Earnings Call Transcript - STEL Q2 2025

Operator, Operator

Thank you for being here. My name is Rebecca, and I will be your operator for the conference today. I would like to welcome everyone to the Stellar Bank Q2 Earnings Release Conference Call. I will now hand the call over to Courtney Theriot. Please proceed.

Courtney Theriot, Investor Relations

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 second quarter of 2025. 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.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.

Bob Franklin, CEO

Good morning, and welcome to the Stellar Bancorp's second quarter earnings call. We are pleased to share our results for the quarter, evidencing the great work our team has performed toward our goals for growth. In the first quarter, we described how we thought the year would play out with our loan volume stabilizing with payoffs in the second quarter, giving us momentum for growth in the third and fourth quarters. Our pipeline is healthy and continues to support growth. We are seeing great results from our business development efforts with new loan originations nearly doubling in the second quarter compared to the first. This is the highest level since 2022, and we believe it marks the return to organic growth. In these efforts, we continue to be supported by the resilient Texas marketplace, which provides Stellar Bank with great opportunities. Our markets have seen M&A activity pick up as many in the country focus on business-friendly states. With this consolidation comes some disruption, and we anticipate a potential for both customer acquisition and talent as a result. Our foundation is our great balance sheet, exhibiting strong capital and liquidity and highlighting our commitment to core funding. These attributes provide us with a good net interest margin and plenty of optionality in the marketplace, a tribute to our disciplined approach around relationship banking. We continue to focus on expanding existing relationships and building new ones. Our strategy is clear: continue to build Stellar into the bank of choice in our markets for small business leaders. We are a community bank, and we understand that our commitment to relationship banking is what will drive long-term value for our shareholders. And with that, I'm going to turn the call over to Paul Egge for further color on the quarter.

Paul Egge, CFO

Thanks, Bob, and good morning, everybody. We are pleased to report second quarter 2025 net income of $26.4 million or $0.51 per diluted share, which is up from net income of $24.7 million or $0.46 per share in the first quarter. These Q2 results represented an annualized ROAA of 1.01% and an annualized ROATCE of 12.16%. Key highlights of our Q2 performance were non-interest expense management and low credit costs, primarily due to low net charge-offs. Our balance sheet grew incrementally, thanks largely to deposit growth, while loans ended the quarter slightly up from the first quarter. During the second quarter, net interest income was $98.3 million, representing a slight decrease from the $99.3 million booked in the first quarter of 2025. This was due largely to lower earning assets and slightly lower net interest margin for the quarter. This translated into a healthy net interest margin of 4.18% in the second quarter relative to 4.20% in the first quarter. Purchase accounting accretion in the second quarter was $5.3 million, which was relatively flat compared to the $5.4 million in the first quarter. Excluding purchase accounting accretion, tax equivalent net interest income decreased slightly in the quarter to $93.1 million from $94 million in the prior quarter and net interest margin, excluding accretion, was 3.95%, down from 3.97% in the prior quarter. Margin performance during the second quarter was impacted by higher funding costs more than offsetting higher yields on earning assets, which resulted in that 2 basis point change versus the first quarter. We should note that the first quarter benefited from some deposit seasonality that impacted deposit funding cost positively in that quarter. The second core margin, excluding purchase accounting accretion and the cost of deposits we experienced, still reflects an incremental improvement from the fourth quarter of 2024. So we continue to feel good about our ability to defend and incrementally improve our top-tier margin profile. Walking further down the income statement, we booked a provision for credit losses of $1.1 million in the second quarter, which was driven primarily by an increase in our allowance for unfunded commitments, due to a nice increase in our unfunded loan commitments during the quarter. To a lesser extent, this level of provision was driven by minimal net charge-offs. Our allowance for credit losses on loans ended the quarter at $83.2 million or 1.14% of loans, which is down 1 basis point from the 1.15% of loans that we had at the end of the first quarter. Moving on to non-interest income. We earned $5.8 million for the second quarter of 2025 versus $5.5 million in the first quarter. Here, we must note that the second quarter benefited from additional earnings from Federal Reserve Bank dividend as a result of Stellar becoming a member of the Fed at the beginning of the second quarter. Next, non-interest expense for the quarter was essentially flat at approximately $70 million. This is better than planned and reflective of our focus on holding the line where we can on expenses. Our solid bottom line results have driven internal capital generation and our ability to maintain a very strong balance sheet and capital position. Total risk-based capital was 15.98% at the end of the second quarter relative to 15.97% at the end of the first quarter. Year-over-year tangible book value increased 10.8% from $18 per share to $19.94 per share, and this is after the effect of dividends and some significant share repurchase activity over the last year. On the topic of share repurchases, we bought back 791,000 shares of our stock at a weighted average price of $26.08 per share during the quarter. In closing, we really like where we sit both financially and strategically. We are positioned to deliver positive operating leverage by adding more scale for the Stellar Bank platform and maintain a really strong balance sheet. We believe this will give us the financial flexibility to be opportunistic. Thank you, and I will now turn the call back over to Bob.

Bob Franklin, CEO

Thank you, Paul. Operator, I think we're ready for questions. Thank you.

Operator, Operator

Your first question comes from the line of David Feaster with Raymond James.

David Feaster, Analyst

I wanted to begin by discussing the growth outlook. We observed that loans stabilized this quarter, which is a positive sign. Could you elaborate on the competitive landscape for loans, particularly regarding origination activity compared to payoffs and paydowns? What factors are influencing the payoffs and paydowns? When do you anticipate that we will start to see originations counteract that challenge and enable growth to accelerate?

Ray Vitulli, President & CEO of the Bank

Originations have nearly doubled in the second quarter compared to the first, and our pipelines support that level of ongoing originations. We have a good understanding of where payoffs are coming from, primarily from property sales. In the second quarter, we originated about $640 million, which contributed to slight growth. We believe that any origination above this level will lead to further growth. Additionally, we consider our carried accounts, which represent our advances minus payments. Given the new loans we are issuing, we expect to see an increase in this area in future quarters, as it has declined in previous periods due to our unfunded loans. The two main factors for moving forward are to maintain our origination momentum and facilitate advances that surpass payments. We are pleased with the rates on these loans, which are healthy. The markets we operate in remain highly competitive, but our bankers are actively working to expand our presence. Recent hires are beginning to make an impact, and we've seen successes in the Dallas market while also gaining market share in the Houston Beaumont region.

David Feaster, Analyst

Okay. That's helpful. And maybe touching on the other side, the funding side. Obviously, there's been some noise there. I'm just curious, maybe the competitive landscape for funding in your markets, and just the strategy and ability to continue to drive core deposits going forward, and would you expect funding costs to kind of remain relatively stable or maybe increase? Just kind of curious your thoughts on the funding side.

Ray Vitulli, President & CEO of the Bank

We've noticed some competitive pressure primarily in the money market sector, while time deposits have been less affected. To address this, we've adopted a measured strategy with selective pricing adjustments as needed. In the second quarter, we recorded our highest dollar amount of new loans closed in three quarters, and the second highest in six quarters. Notably, 50% of these loans were to new customers who had not previously banked with us at Stellar Bank. Our strategy is to grow our existing customer base while also exploring opportunities in the market, positioning us well for future success.

David Feaster, Analyst

Okay. And just last one for me. You guys have done a great job managing expenses. I'm curious, as you look at expenses going forward, is there more wood to chop on that front? Or just given the disruption around you, whether there could be some opportunities to maybe invest in new talent and maybe be a bit offensive here?

Paul Egge, CFO

So, I'd characterize our expense management as holding the line where we can. And that is, so that we can be opportunistic when the right opportunities come up as opposed to feeling like we're in a deficit on spend and more spend would put us in a less optimal place. So the net effect of our strategy of holding the line where we can opens up the possibility to be opportunistic, but it's still a dynamic where we're going to focus on holding the line where we can so that the revenue growth outpaces the expense dynamics.

Bob Franklin, CEO

Yes, David, from that perspective, we are certainly open to new talent. We continue to seek additional talent that would assist us in growing the bank. The positive aspect for us is that the back office development needed for our transition beyond $10 billion is largely complete. Therefore, we do not anticipate growth in that area, but we are definitely looking for more talent to help foster the bank's future growth. We will not allow that to hinder our acquisition efforts.

Operator, Operator

Your next question comes from the line of Will Jones with KBW.

Will Jones, Analyst

So Paul, if I could just weave together some of the commentary on just maybe the deposit cost competition landscape. And just mirror that with your desire to see some growth in the back half of the year. Could you just piece out what the implications are for how the margin could trend as we move into the third and fourth quarters of this year?

Paul Egge, CFO

We feel confident in our ability to maintain our margins. There has been some change in our funding sources, which is largely by design. In the second quarter, we leaned less on FHLB borrowings and brokered CDs. Instead, we utilized a lower-cost FHLB funding option, an interest-bearing demand broker, which we have reduced our exposure to. This shift contributed to changes in our funding costs compared to the first quarter. Overall, we are optimistic about our position regarding the low points in our reliance on wholesale funds at the end of the second quarter. The composition of our funding will influence our ability to enhance our margins. If this composition remains consistent, we can likely improve our margins gradually. If we continue to reduce our reliance on wholesale funds, we might achieve better results. Our focus on maintaining core operations will help us sustain what we believe is a fundamentally strong margin. If we see any regression, we are confident in our ability to defend our current standing.

Will Jones, Analyst

Yes, that's great. I appreciate that helpful response. I know you talked in the past just about your desire to see securities balances grow a little bit. But as I look this quarter, they at least leveled out on an average basis here. Did you feel like you've done all you need to do in terms of building up that bond portfolio?

Paul Egge, CFO

Yes, we are satisfied with the current size and will continue to grow gradually, focusing on increasing our loans. We have a strong liquid balance sheet. When comparing average balances in the second quarter to the first quarter, the first quarter benefited from seasonal factors in our government banking business. We did invest in some securities later, which led to higher average balances in the first quarter. This was a seasonal anomaly. Our position in the second quarter aligns with our targets, and we aim to maintain similar asset percentages as we grow.

Will Jones, Analyst

Okay. Great. And then, excess capital that you guys have, I mean it's a high-cost problem, and you're deploying that somewhat through buybacks, but valuations have also moved a little bit from where you bought back in the first and second quarter. Does that still play a role near term? Or do you really lean more into the organic growth as you see that opportunity picking up?

Paul Egge, CFO

Organic growth is our primary focus for capital allocation. Additionally, we see value in maintaining flexibility for other strategic capital uses. Share repurchases are also a valuable option for us, and we were quite active in the first half of the year. Our approach to share repurchases is influenced by price, and as demonstrated in the first half of the year, we are prepared to be aggressive when we believe the situation warrants it.

Operator, Operator

At this time, your next question comes from Matt Olney with Stephens.

Matthew Olney, Analyst

Thanks. Good morning, everybody. I want to go back to the loan growth discussion and dig in more to the originations that improved this quarter that Bob noted. Any color on the mix of originations? I know you guys have been working hard, building out kind of C&I, more of a middle market strategy over the last year or so. Just any color on that progress and just the overall origination mix?

Ray Vitulli, President & CEO of the Bank

We've had a good mix of Commercial and Industrial loans in that area. Our concentrations in Commercial Real Estate and Construction and Development have decreased to really low levels. There’s been some recovery in those areas as well. We continue to seek out opportunities in the Commercial and Industrial sector, and we're pleased with our progress not only in the second quarter but also over the past few quarters. The overall mix has remained consistent with our origination efforts, though it reflects higher total dollar amounts.

Matthew Olney, Analyst

Okay. I appreciate that. And then, I want to go back on to the expense discussion. And Paul, you mentioned the bank has done a nice job, kind of, holding the line so far this year and it looks like expenses are pretty flat year-over-year through the first half of the year. Based on where we're at today, do you think it's reasonable to assume expenses just continue to remain flat for the remainder of the year in '25 as compared to '24, absent any of those investments that you will be opportunistic looking for?

Paul Egge, CFO

Absent opportunistic investment, that's the goal, is hold the line right here. We're really pleased with the fact that we've been able to outperform where we initially budgeted and where we initially kind of positioned the expense story. And we're really pleased with us actually kind of meeting last year's guidance and beating this year's guidance. So that's the goal. But part and parcel to that is having that flexibility to be opportunistic.

Matthew Olney, Analyst

Yes. Okay. Makes sense. And then, on the discussion around the core margin, I think we've talked about kind of an intermediate-term goal is getting back to that 4% margin and we've talked on this call about the deposit cost competition, a little bit more of a headwind now than before. Is that 4% core margin? Is that still a reasonable goal? And do you see any kind of potential Fed cut that we could see later on this year and next year? Do you see that benefiting the margin as you stand today? Or is that potentially more of a headwind if that were to happen?

Paul Egge, CFO

The margin will improve. When rate cuts occur, there may be some initial adjustment noise that is difficult to interpret. However, the overall normalization of the yield curve is advantageous for our industry. We are optimistic about our position, even with some point-to-point inversions, particularly in our area of the yield curve. As the front end decreases and if rate cuts happen, it presents additional structural opportunities for our margin to strengthen over the medium term. There may be some immediate noise, but we are confident in our position and aim to work our way back to a 4% margin.

Matthew Olney, Analyst

I appreciate your comments, Paul. Regarding capital, you previously mentioned the buyback. Additionally, you talked earlier this year about paying down some debt. It appears there may be another tranche or two of debt that could be redeemed. Could you provide any updates on the debt situation at this time?

Paul Egge, CFO

We're looking at that kind of in conjunction. It's in the playbook with share repurchases and how we think about kind of the uses of our excess here. So we are evaluating that really in line with the other options out there. So it's certainly there for us to consider.

Bob Franklin, CEO

Yes, Matt, I think the pace of the conversations have ticked up a bit. And I think one of the things for us is just to make sure we're mindful to stay disciplined around pricing. And I think, some of the exuberance sometimes causes some disruption around pricing for some of these things. But I think we always make sure that we want to not do any damage to the franchise that we already have. And we are still seeking partners to help build the balance sheet, build the bank, and there's still some opportunities out there for us. And so we're going to continue those discussions.

Operator, Operator

Your next question comes from the line of John Rodis with Janney.

John Rodis, Analyst

Yes. I guess most of my questions have been asked and answered. But Paul, maybe just one on the other income line item. You highlighted the Fed dividend. So all things equal going forward in the second half, does the other income line probably trend back more towards sort of the first quarter level?

Paul Egge, CFO

Yes, there are some lumpy pieces that fall into other income. One of them is our SBIC income, which sometimes can add some lumpiness to it. But the key and ongoing component to other income is going to be the new entrant of these dividends as a byproduct of holding Fed stock and being a Fed member. So that's going to go on in perpetuity. Some of the other dynamics, I can't promise that there won't be volatility in that line. But net-net, what drove most of the difference between the first quarter and the second quarter is an ongoing benefit.

Bob Franklin, CEO

Thank you, operator, and thank you to all of you that have joined the call this morning and we are adjourned. Thank you.

Operator, Operator

Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.