Earnings Call Transcript - STEL Q1 FY2025

Operator

Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Stellar Bank third quarter earnings call. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press the star key followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. At this time, I would like to turn the conference over to Courtney Theriault, 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's earnings call will be led by our CEO, Bob Franklin, and CFO, Paul Iggy. Also in attendance today are Steve Riesloff, Executive Chairman of the company, Ray Batuli, 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 Limitcation Reform Act of 1995 as amended. We intend all such statements to be covered by the state 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 in 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 statement 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.com, for additional information about the risk factors associated with forward-looking statements. At the conclusion of our remarks, we will open the line and allow time for questions. questions. I will now turn the call over to our CEO, Bob Franklin.

Bob Franklin, CEO

Thank you, Courtney. Good morning and welcome to the Stellar Bancorp 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 banker's emphasis on getting the full client relationship. 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 markets stable. Paul will provide more detail on our expenses during the quarter, including some one-time expenses and some increased advertising spend. As we continue to strengthen our capital position, we have repurchased shares and we have paid down $30 million of our subordinated debt just after 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 Eggie, our CFO, for more content.

Paul Egge, CFO

Thanks, Bob, and good morning, everybody. We are pleased to report third quarter 2025 net income of $25.7 million, or $0.50 for diluted share, as compared to net income of $26.4 million, or $0.51 per share in the second quarter. These Q&A represent an annualized RLAA of 0.97% and an annualized RLATCE 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. So 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 in net interest margin for the quarter. This translated into the net interest margin of 4.2% relative to 4.18% posted in the second quarter. Purchase accounting accretion in third quarter was $4.8 million, down from $5.3 million in the second quarter. So if you were to exclude purchase accounting accretion, tax equivalent net interest income increased by 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 name excluding purchase accounting accretion back to a 4% level, and we continue to feel good about our ability to defend and perhaps incrementally improve on 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 provisions. For a year-to-date perspective, our net charge-off totaled $3.7 million, or approximately seven 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 other 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 due to an increase in salaries and benefits, and to a lesser extent, increases in professional fees and advertising. Salary and benefits expense included severance expenses recorded relating to two upcoming branch closures in the fourth quarter, which totaled about a half million dollars, as well as elevated medical insurance expenses relative to prior quarters. We view our third quarter expenses as an outlier, and we expect fourth quarter expenses to be closer to our run rate for the first half of the year. So 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 in 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, and that is after the effect of dividends and meaningful share repurchases. I should note that our share repurchases in the third quarter was 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 as 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 bring us all back over to Bob.

Bob Franklin, CEO

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

Operator

Thank you. We will now begin the question and answer session. If you have dialed in and would like to ask a question, please press star 1 on your telephone keypad to raise your hand and join the queue. We'll take our first question from David Feaster at Raymond James.

David Feaster, Analyst — Raymond James

Hi. Good morning, everybody. I just wanted to start on – let's start on the growth side. You know, I know somewhat of a 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, you know, what's driving the payoffs and paydowns? You know, how much of that is competition versus just, you know, asset sales and those kinds of things? And then just how do you think about the growth outlook as we look forward? I mean, you know, Texas is a very competitive market on one hand, and, you know, that's – maybe that could be a headwind, but at the same time, you talk 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 – taking that all together, like, how do you think about growth and just any insights you can provide on that?

Ray Vitulli, CEO

hey sure david um yeah so start maybe a little bit with what what's uh what's impacting the growth um is when we talk about the payoffs like like you asked the color around that so um you know payoffs this this last quarter were about 50 million more than the previous quarter so um you know we we talked about a run rate of around 300 million of payoffs they were 330 in the 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 refinance elsewhere. So those are the things that we take a look at around, you know, one, and as Bob already mentioned, us remaining disciplined around full relationships. So some of that, it will go away. But on that refinance elsewhere, if, you know, 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 in the waterfall is, you know, we've talked about it before, but we call our carry, which is our advances versus our paydowns and scheduled payments. And as Paul mentioned, you know, we had a reserve related to unfunded that continues to grow. but we're still not seeing the lift from that. So compared to the previous quarter, that was almost another $50 million of increase in payments and paydowns exceeding the advances. So 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. The 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, compared to last year, first three quarters, we're up 62% of loan originations and in the mix that we like with a little bit more CNI in that mix. So things are headed in the right direction. We just have to continue to convert on our pipeline, and the pipeline remains healthy. I think a little bit of the originations that were down compared to the previous quarter We're really due to, in some cases, it's competitive, obviously, but also just some things that are going to get pushed into the fourth quarter. But the pipeline remains healthy, and we're really pleased with where we stand there. That's great.

David Feaster, Analyst — Raymond James

Maybe touching on the credit side a little bit, you know, concerns are, you know, they've gotten 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 um and then secondarily i was just hoping you could maybe touch a bit on your approach to credit you know collateral management stress testing ongoing monitoring it seems like some of those are are what's you know maybe investors are concerned about um you know in the industry so just was hoping you could elaborate maybe a little bit on your process and and your approach to managing

Bob Franklin, CEO

credit yeah i think the the best way to manage credit is is when they come in through the front door david i mean so that's that's how we manage credit most of the time however you know we do stress testing we do all the things that that folks do to monitor portfolios and you know we're We're moving our portfolio from what was two smaller community banks into a larger community bank, and it has a different look. I think you've seen it 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 feel comfortable there. We're able to make money there. We're changing the mix a bit to try to have a little more emphasis on stickier C&I credits. Now, we are 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. So 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, for that matter, tariffs and the various things that are happening today, I think are being absorbed pretty well in Houston and Dallas and the markets that we're in, Belmont. So we feel supported by our markets, and I think it's about decision-making with them, and that's kind of how we approach it.

David Feaster, Analyst — Raymond James

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. You know, cost declined. Just wanted to get a sense of some of the drivers behind that. You know, how much of that is, you know, new clients versus, you know, increasing liquidity or relationships with existing clients. You know, and then just, you know, again, with the liquidity build, I mean, even after paying down borrowings and buying a little bit of security, I'm just kind of curious what your plans are for some of that excess liquidity going forward.

Ray Vitulli, CEO

Let me touch real quick on the deposits, on the deposit growth piece. So really pleased there, as we've already mentioned. So, you know, of our new deposits that were onboarded in the quarter, 51% were to new customers that had not been here before. And we've seen that kind of hover in that 40% to 50% all year, which we really like. and we think that's really a reflection of continued brand awareness of Stellar, our bankers that are really having good success with market share gains. You know, we've had improvement in our net promoter score, really getting into like 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 this expansion of our existing customer base, which, you know, represents that other 50%. But really the growth is really around those new accounts and the deposits associated in that that are well exceeding in dollar amount, the closed accounts and are carried was nice and gave us a little lift.

Bob Franklin, CEO

Yeah, David, we just feel very strongly that low-cost deposits is something that everyone's going to be fighting over and something we put a big emphasis on in any relationship that we have. And 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 both in loans and securities is something that we intend to do in the future. But we want to grow the loan portfolio. You know, we want to, that's where we grow customers, and that's how we continue to grow the bank. And it's important to us to continue on that lock. A lot of turmoil in our markets, a lot of M&A going on, a lot of, so it's given us opportunity for customers. It's given us opportunity for new employees and people to join our company, which is great. I think it's – but it also adds some negatives to it in that you have new players in that want to buy the market, and you're seeing some interesting things around not only pricing but covenant packages and sort of credit light. And we're not going to join that party. That one 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, which I think we are, from a customer acquisition standpoint, we'll continue – we will grow the bank. So that's kind of how we're approaching it.

Ray Vitulli, CEO

That's helpful. Thanks, everybody. Thanks, Ned.

Operator

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

Stephen Scouten, Analyst — Piper Sandler

Hey, good morning, everyone. 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 a seasonal strength of some of our government banking deposits. And, in fact, last year we had about a $200 million deposit that came in in the last day of 2024. It's kind of hard to predict as it relates to that. we'll keep you guys abreast if there's anything that majorly kind of creates a meaningful deviation from norm, as we did, I think, last year in telling you all just how much represents what we would call seasonal excess. So, we'll note that when we report the third quarter, fourth quarter, I should say, if and when some of that tax revenue seasonality comes in before year end a lot of it really hits in july january and february and it's kind of gone by uh march uh but sometimes and last year was a great example where sometimes it comes in right before the end

Bob Franklin, CEO

of the year but that that's not reflected in this quarter's deposit right it doesn't happen until

Stephen Scouten, Analyst — Piper Sandler

late in the fourth quarter precisely perfect great that's great color um when uh you were talking a a little bit about the expense ratio, saying it looked like this was maybe a bit of an outlier this quarter and could 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 hang around in 26, or should we see just some kind of general inflation build from here?

Paul Egge, CFO

I'll say, to be more specific, I said that we'll see fourth quarter earnings closer to our first quarter, first half run rate than what we posted in the third quarter. So it might not be just as great as the $70 million per quarter we were posting in the first half year, but definitely closer to that than the $73 million we posted in the third quarter. Separately, we will see some inflation. I mean, as you guys 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 kind of stop the creep in expenses, particularly as it relates to a lot of what we had to build in crossing over the $10 billion threshold. We're in optimization mode on a go forward, and we've been really pleased at 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 really 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

Next, we'll move to Will Jones at KBW.

Will Jones, Analyst — KBW

Hey, great. Thanks. Good morning, guys. Hey, 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 goes on, that felt like kind of the overarching, you know, 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 Will that ability to defend, will that really be more of just some tailwinds from fixed repricing, or do you intend to be relatively aggressive lowering deposit costs from here?

Paul Egge, CFO

No. We're going to be focused on lowering deposit costs where we can. That's predominantly going to be on more of your specials and exception-level pricing. Naturally, we've got some index pricing for certain deposit products that we're going to get immediate benefit from when rates change. So we feel really good about kind of the initial repricing dynamics. And then separately, there is some tail trends that are helping us in how our securities and loans reprice. So we're still in kind of a pretty good backdrop to defend that margin. You know, as the debt gets reshuffled at every rate cut, there could be some timing distinctions. but we feel like we've got the benefits are likely to sufficiently mitigate the drawbacks of how those repricings go on. So we're feeling good about defending it. Actually, we're pleasantly surprised to have gotten the 4% name excluding purchase county accretion as fast as we did. We certainly did not promise that to the market and did not expect it necessarily to to materialize as quick, but we're really pleased that we were able to do that, notwithstanding being a little less loaned up than what our budget and forecasts are and our plans to drive loan growth really are.

Will Jones, Analyst — KBW

Yeah. I mean, well done there. And could you just remind us, is there a kind of a terminal interest period deposit data that you guys are trying to manage to through this cycle, maybe just as you look at what you were able to accomplish on the up-rate 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. So just like on the upswing where we weren't as aggressive in necessarily moving a lot of our kind of base sheet rates, and we were more focused on, okay, how do we manage this exception population and this index population? 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, and it's a nuanced approach. We feel like we're approaching it with more discipline than we really ever have in 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 largest absolute value exception customers, and that's all reasonable ask and uh it's so far has uh functioned pretty well uh in the september rate cut so we'll follow the same game plan as we go forward yeah okay um and then maybe to follow up as you know

Will Jones, Analyst — KBW

we've talked about deposits and the growth that's happened there and kind of the excess liquidity that you have as a result um you know if we do you know continue to you know find the pay down bug a little bit and to the extent loans you know don't you know really ramp up in growth meaningfully in here in the near term could you look to be a little more you know opportunistic

Paul Egge, CFO

adding to the bond book from here it's definitely an option and 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 really nice foundation to grow upon. So we think that flexibility is going to allow us to be opportunistic when more meaningful loan growth presents itself or when other strategic opportunities can present themselves. So, we are very pleased to be having a very healthy and strong balance sheet. Yeah.

Will Jones, Analyst — KBW

Okay. Fair enough. That's it from you guys. Thank you. Thanks. Go ahead.

Operator

As a reminder, if you would like to ask a question, please press star one. We'll go next to Matt Olney at Stevens.

Matt Olney, Analyst — Stephens

Thanks. Good morning. I wanted to circle back on the loan growth discussion, and, you know, we talked about the elevated payoffs a few minutes ago. I'm just curious, when do you expect this to slow? I mean, we're seeing rates move lower in the fourth quarter, and 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.

Ray Vitulli, CEO

Hey, Matt. So, one of the things that we will get a lift—we will get a lift from our advances exceeding our paydowns and payments, and that's—when you go back and look at our history of when we were getting a lift, it patterns kind of this—it matches up with our loan originations. So, as we said, we've—loan originations are up 62%. We will get some lift there, whether that's maybe a couple quarters away from that helping us and not taking away from loan growth. So that's kind of in the good news category. I think we're going to have to manage through the fact that we've got the way the portfolio, the nature of the portfolio of this, you know, $300 million to $350 million of payoffs that we have. And we'll do our best to try to limit that through some of those loans that we're refinancing elsewhere to put our best foot forward, but the real story is going to be on that side. It's going to be the funded portion of the new loans that we originate. So, again, our pipeline's healthy. If we're in this, you know, like last quarter, $600 million of origination, that's getting us closer to where that will get the fundings, even with the payoffs, to get us, as you know, last quarter we had a slight gain or slight increase in net funded loan balances. So, it's a matter of delivering on that pipeline and continuing on the path that we've seen in the last couple quarters and really year to date. You know, we've said before that we thought growth would manifest in the second half of the year. Of course, we still have the fourth quarter, but, you know, going into 26, we feel good that we will pivot to that. Okay. Appreciate that, Ray. And also

Matt Olney, Analyst — Stephens

want to get the 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 Seller Bank. Thanks.

Bob Franklin, CEO

Yeah, Matt, we continue to have conversations. We've talked to a lot of folks. I think you've seen some transactions that we'd have some interest in, 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 that we built and the deposit base that we built. And as we look at partners out there and how they've structured their funding, it would not behoove us to join somebody that that takes away from the funding base that we have just to just to be larger so i think what we want to do is make sure that we find the right partners to think about the world the same way we do and fund themselves in a similar fashion so we continue to have conversations um i think there's a possibility we can be active in this space but we're going to be careful about how we approach it okay thanks for the commentary and uh

Matt Olney, Analyst — Stephens

agree it's a it's a high class problem to have protecting the balance sheet um and just just lastly for me um i guess over to paul paul i heard you mention the purchase accounting accretion and prepared remarks um looking for the updated fair value mark on that on that portfolio

Paul Egge, CFO

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

Matt Olney, Analyst — Stephens

Okay, guys. Thanks for your help.

Paul Egge, CFO

Thanks, Matt.

Operator

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

Bob Franklin, CEO

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

Operator

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