Earnings Call Transcript - STEL Q1 2025

Operator, Operator

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, Robert Franklin, Jr.

Robert Franklin, Jr., CEO

Thank you, Courtney. Good morning, everyone. And welcome to the Stellar Bancorp, Inc. first quarter earnings call. I begin by thanking our outstanding team at Stellar whose solid work continues to build a strong financial institution for our communities. As we entered 2025, we spoke of our focus on the customer, internal, existing, and prospective. Our focus is unchanged. We must acknowledge, however, that the administration has introduced a fair amount of uncertainty into the economy. Though it is too early to see signs of impact, in all on our communities. Our team will remain disciplined around credit as we monitor the impact of the new tariff policies on our customers and our communities. We continue to see opportunities for new customer acquisition. And our pipelines are growing. While we are also seeing significant commercial real estate pay downs, as interest rates begin to stabilize. Given these conditions and the economic climate, we will proceed cautiously. Challenges also provide opportunity. We took advantage of our strong capital position to return capital to our shareholders through meaningful share repurchases during the first quarter. The repurchases are in line with our goal to manage our capital to the benefit of our shareholders. We remain focused on building the great foundation our team has put in place. Given the economic uncertainty of the first quarter, we believe that growth will be pushed to the third and fourth quarters of the year. Although conditions make us cautious, our dynamic markets and our team keep us optimistic. I will now turn the call over to Paul Egge, our CFO, for more details on the quarter.

Paul Egge, CFO

Thanks, Bob, and good morning, everybody. We are very pleased with our first quarter 2025 net income of $24.7 million or $0.46 per diluted share, which represents an annualized return on average assets of 94 basis points and an annualized return on average tangible common equity of 11.48%. Key highlights of our first quarter performance included a reduction of noninterest expenses and a meaningful repurchase of common stock along with the continuation of core net interest margin progress after seeing inflection during Q2 2024. Our balance sheet shrunk during the quarter on a point-to-point basis, largely due to the seasonal outflow of government banking deposits and cash balances that had significantly inflated our balance sheet at year-end, which we acknowledged during our last earnings call. Looking at it on an average basis, linked quarter decrease in assets was much less significant and more reflective of the decrease in loans experienced during the quarter. The net result is a smaller but stronger and more core balance sheet. With a very strong capital position. That's notwithstanding our share repurchase activity during the quarter. And if not for two fewer days to earn interest in the first quarter, earnings would have been up relative to the prior quarter. Notwithstanding broader economic uncertainty, we believe we are well positioned to return to a reasonable level of growth during the year, albeit later than initially planned. Incremental growth will position us well to deliver operating leverage and earnings improvement in Q2 2025. Net interest income for the quarter was $99.3 million, representing a decrease from the $103 million booked in the fourth quarter. This was largely due to lower purchasing accounting accretion and two fewer days to earn interest due to the ninety-day quarter. This translated into a net interest margin of 4.2% in the first quarter relative to 4.25% in the fourth quarter of 2024. Purchase accounting accretion in the first quarter was $5.4 million relative to $7.6 million in the fourth quarter. Excluding purchase accounting accretion, tax equivalent net interest income decreased slightly in the quarter to $94 million from $95.5 million in the prior quarter, and net interest margin excluding purchase accounting accretion 3.97% up from 3.94% in the prior quarter. Key drivers to the strong margin performance during the first quarter included the relative stability in maintaining a strong proportion of noninterest bearing deposits, which represented over 37% of our deposit base, a 14 basis point improvement in our cost of funds, driven by a 21 basis point improvement in our cost of interest-bearing liabilities. Also, we had incrementally higher securities yields and strong loan yields after excluding purchase accounting accretion. Walking further down the income statement, we booked a provision for loan losses from the first quarter of $3.6 million. Combined with minimal net charge-offs of $163,000 during the quarter, this brings our allowance for credit losses on loans to $83.7 million or 1.15% of loans, from $81.1 million or 1.09% of loans at the end of the prior year. Moving on to net noninterest income. We earned $5.5 million for the first quarter, versus $5 million in the fourth quarter, noting that the first quarter benefited from small gains on sales of assets. Next, noninterest expense for the quarter was down $5.1 million to $70.2 million from $75.3 million in noninterest expense during the fourth quarter. This is better than planned and reflective of both some timing-driven dynamics and our focus on holding the line on expenses where we can. 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 15.94% at the end of the first quarter, relative to 16% at the end of Q2 2024, and 14.02% at the end of Q2 2023. Our regulatory capital ratios at the bank actually picked up. Year over year, tangible book value per share increased 14.3% from $17.23 to $19.69 per share. And that is after the effect of both dividends and the share repurchases. 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 first quarter, we acted on this optionality through share repurchases buying back 1.4 million shares of our stock at a weighted average price of $27.99 per share. Additionally, we repurchased 679,000 shares at a weighted average price of $25.83 per share, since the end of the first quarter, representing in total nearly 4% of our shares outstanding at year-end. The board of directors also authorized a new share repurchase program, which allows us to repurchase up to $65 million in shares through February. While our preference would be to deploy capital through growth and M&A, we appreciate having the flexibility to pursue capital optimization through buybacks when appropriate. In closing, we really like where we sit, both financially and strategically. We've laid the foundation to support adding more scale to the Stellar Bank platform and it remains our goal to deliver positive operating leverage during the year while maintaining a strong balance sheet and the financial flexibility to be opportunistic. Thank you, and I will now turn the call back over to Bob.

Robert Franklin, Jr., CEO

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

Operator, Operator

At this time, I would like to remind everyone in order to ask a question.

David Feaster, Analyst

Press star then the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. The first question comes from David Feaster from Raymond James. Your line is open.

Robert Franklin, Jr., CEO

Good morning, everybody. I want to start on the loan side. It sounds like we're cautiously optimistic about the potential for accelerating growth. This might, you know, hopefully be the trough here. Did you just I guess, first off, touch on the pulse of your clients? Obviously, there's a ton of uncertainty out there. So I'd be curious. What are you hearing from your clients and just how the pipeline's trending? And how much of this decline is a function of payoffs and paydowns being elevated and higher than expected versus slower originations given the uncertainty? Let me set this up a little bit, and then I want Ray to come in and fill in. One of the things we've been focused on, David, is when you see an MOE come together, especially the way ours did, as two real community, small community banks combine into a bank that's over $10 billion in assets, there's some redistribution of how the loan book should look. And we've been attempting to reconfigure what that loan side of our balance sheet looks like. In other words, be able to do across the board any type of loan that we want to do without being totally reliant on these smaller real estate loans that we had all done in the past as a smaller community bank. So across the board, there’s a real better focus on it, and letting some of this stuff roll out. So we had we started this journey, we were over the regulatory guidance in both categories, both C&D and CRE. So what we've done is focused on getting those balances back down to what looks more like a larger bank balance sheet. So we've done that. We continue to see some of that roll off that we've really kind of focused on letting roll off. And then as we add to it, it's a little bit different focus on what we're adding to it. But I'm gonna let Ray fill in the gaps here.

Ramon Vitulli, CRO

Thanks, Bob. I'll get David on your question around pipeline and kind of the waterfall. So in the first quarter, our loan originations, and this kind of goes to this the build of the pipeline and what we're seeing, if you compare it to the past four quarters, we've had two good quarters of solid originations that were in excess of the fourth quarter of twenty-four and the first quarter trending in the right direction, and it supports what we're seeing in the pipeline as far as deal flow as well as just the absolute value of the pipeline both in expansion of our existing customer base and new market share gain opportunities. So if you look at where that's building, as long as we can convert, it'll continue to generate higher loan originations and then we've got to see where those fund. But if they fund the way we think they're gonna fund, that obviously gives us a lift to offset the payoffs, which have been about $275 to $300 million a quarter. The other component of the waterfall that really goes to what Bob just talked about is what we call our carried loans, which is our advances less our payments on the whole book. And because of the posture that Bob mentioned, you know, that has not given us a positive lift in the carried, which will help the overall loan growth story, which, as we said, we should see in the second half of the year. We're seeing a little bit of growth in our unfunded commitments, which is good, which is kind of a leading indicator for that. So we feel good about it. Our team is laser-focused. We know what's needed on the origination side in order to generate the growth. And, to your question about customer sentiment, it's kind of the way we're talking about it. Still early to tell. We have seen maybe some pull through of things like some inventory purchases early. But we still think it's too early in that aspect. And, as far as deal flow, we're seeing on a committee and what we're seeing in the pipelines, it's positive.

Robert Franklin, Jr., CEO

Okay. Okay. That's great color. And could you maybe just touch on the deposits side? I mean, you used some pretty strong language in the press release, stating the market's intensely competitive. Could you just elaborate on that and touch on some of the trends you're seeing? Obviously, exclusive of the government deposits, just where are you having success winning new relationships? How do you think about core deposit growth and opportunities to further optimize funding and drive some further improvements in deposit costs even exclusive of Fed cuts?

Paul Egge, CFO

Well, we really like our new account origination story. So you know, first quarter, we onboarded in both number and dollar amount more than the fourth quarter. The mix is consistent with our overall bank mix. And, you know, you can't talk about new accounts without closed accounts. Closed accounts were at the lowest level in four quarters. So, and of those new accounts, close to 40% were to customers that weren't here before, which we really love that trend. I think it talks about the stellar brand. We sit in the market. Our success in having doors open for us, and we continue, you know, as we're sixth in the MSA and deposit market share, we see the opportunity to continue to take market share gains.

Robert Franklin, Jr., CEO

Okay. That's great. And then just maybe shifting gears to credit quickly. You know, it's not surprising to see some migration in non-accruals. It seems like it's across several segments, but maybe notably in CRE. You know, you obviously have a track record of being very conservative on credit. I was just hoping you could touch on what you're seeing on the credit side and maybe what you're watching more closely, especially anything that you're more concerned with just given the trade wars and tariff issues.

Joe, CLO

You know, our migration was in the owner-occupied CRE. Not for I wouldn't classify it as anything related to tariffs or just some over-occupied CRE with management issues. And then we noticed that and granted it appropriately and put appropriate reserves against it. What we're seeing, as Ray said, it's a little early in this tariff issue to know how it's going to affect it. There's a lot of talking, but we haven't really seen much in the way of any deteriorating financial reports from the customers. So I think we're in a wait-and-see attitude, but we're just taking a cautious approach as we examine new credits. We've always had a strong focus on primary sources of cash flow. We'll continue to do that as we grade our credits and look at our credits. We want to know how we're going to get paid back and then what's the secondary source of repayment to be that will follow on behind that.

Robert Franklin, Jr., CEO

Okay. Terrific. Thanks, everybody. You too.

Operator, Operator

The next question comes from Matt Olney from Stephens. Your line is open.

Matt Olney, Analyst

Hey. Thanks. Good morning, guys. I want to dig more into capital. I think Paul mentioned the active buyback in the first quarter and even more activity in recent weeks. I think that makes a lot of sense considering the valuation and the capital. Just love to hear just updated thoughts from capital from here, including consideration for additional debt redemption just with the context, of course, of economic uncertainty.

Robert Franklin, Jr., CEO

Yeah, Matt. I think, you know, we're continuing with the same posture that we've had on trying to decide what the right use of the capital is. We continue to build capital at a pretty significant rate. There's some sub debt that we are thinking about possibly retiring. I think we wait on the benefits of what buybacks might be or what refinancing that debt might look like and what benefits that are, but we're losing capital treatment on some of that sub debt. We're going to make a decision around that a little later in the year, but we continue to build capital, which allows us some flexibility. It's certainly enough capital for what we think our growth is going to be over the next couple of years. And so we have the ability to use it for some other things at this point. We haven't given up on M&A. I think M&A is still out there for us, although I think it's been put on hold like a lot of other folks. But I think people are still talking. We're still talking to folks about transactions. I think it's a little bit different if you consider public to public versus public to private. Those conversations are a bit different. Most of ours tend to be with the private at this point. But so all of these things are still on the table, and I think we're going to have to balance out over the rest of the year as to what the best place and utilization of that capital is. But that's kind of how we're approaching it.

Matt Olney, Analyst

Okay. Appreciate that. And I guess other capital options, some of the peers are considering at this point. I'm curious if this is on your radar as far as, you know, a focus, just whether it's security purchases, whether it's kind of a smaller wholesale trade, with some wholesale funding, or even a few years ago, I think you guys purchased some loans as well. Are those other options that are being considered, or is the focus still on, like you said, that the buyback with the kind of a longer-term mile on M&A?

Robert Franklin, Jr., CEO

Yeah. I mean, we're a core bank, and this is where we keep our focus. We don't manage this thing on a quarter-by-quarter basis. We've got a very good game plan around what we want this to look like in the markets that we're in. And we're on track to build this bank the way that we think that it ought to be built in our market. So to do something on an ad hoc basis is probably not in our DNA. So we're going to continue on an organic basis to focus on the great markets that we're in. Look for opportunities to add the partnership with someone else in the future. And then we can look at dividends or buybacks as those opportunities arise. I think we tend to like buybacks just because from a tax standpoint, it seems to be a better way to return capital to shareholders. Although, you know, dividends are nice also. So we'll continue to manage that as we go along.

Paul Egge, CFO

Yeah. And for what it's worth, you've seen both. You've seen the increased dividends in the fourth quarter, and we've chosen to be selectively active on the share repurchase. So we appreciate that flexibility, and we think we sit at the catbird seat relating to having plenty of options and the ability to do a lot of things. But I'll end where Bob started. Our goal is to continue to be a core bank.

Matt Olney, Analyst

Okay. Appreciate the commentary there. And then, I guess, switching gears, the other positive theme in the quarter that I saw was just a nice improvement on your interest-bearing deposit cost. Would love to appreciate just how much more room you think you have to bring that down, whether the Fed kind of stays put or continues to cut rates and then for margin, ticks a little bit higher, would love to appreciate your view of the outlook there. Thanks.

Paul Egge, CFO

Certainly. Well, the first quarter, we saw what I'll call, the full quarter impact of a lot of the rate activity you saw in the back half of the year, including in the fourth quarter. We work every day to try and optimize that mix, but we kind of see that we've gotten most of what we could out of that. Note our cost of deposits did not skew as high as a lot of our peers. So know, we're going to continue to work on bringing that down. But, ultimately, it's going to continue to be a slog. I don't think we're going to see the same kind of improvement in the second quarter from the first quarter. But day by day, that's our job—continue to drive an optimal mix of deposits and try to grow that base. So we'll be working just as hard, but the incremental return in terms of improvement is going to be hard to compete with this prior quarter's improvement.

Matt Olney, Analyst

Okay. And, Paul, I guess the last part of that question was just around the core margin, I think, the 3.97% excluding the accretion. Would love to hear thoughts on kind of directionally where that could go.

Paul Egge, CFO

Well, we're pleased with showing incremental improvement, three basis points quarter over quarter. Our goal would be to get a four handle back on our core net interest margin, excluding purchase accounting adjustments. And, we think we're on that path. It's just given a lot of the uncertainty, we'd rather underpromise and outperform on that front. Every basis point from here is going to be a win, and we're just keeping our nose down to drive a core balance sheet. With that, we believe will come incremental improvement. But we're already in rare air so, every basis point we get from here is going to be considered a pretty good win, and we're going to continue to work on it.

Matt Olney, Analyst

Okay. Appreciate you taking my questions. I'll step back.

Operator, Operator

Again, if you do have a question, kindly press star followed by the number one. The next question comes from Will Jones from KBW. Your line is open.

Will Jones, Analyst

Yeah. Hey, guys. Good morning. Thanks for the questions. So I wanted to circle back to the growth conversation. Ray, maybe if you could just help us frame what you kind of see and know is upcoming on the paydown front. I know it's been obviously a headwind for you guys, but more so a headwind for the broader industry. So just to understand what the bar to chin is on the paydown front. And then just to the comments about growth being more back-loaded, I know that you guys are used to kind of growing in that five to eight percent range. Would you expect we would immediately get back to that level or is it really more of a slow grind higher as we move into the latter half of 2025?

Ramon Vitulli, CRO

Yeah. Will, on payoffs, I mean, I think what we feel, the behavior of the portfolio is something like $275 to $300 million a quarter is kind of what we're experiencing in absolute dollar terms. On the growth side, you know, I think we talked about going into the year more like low to mid-single digits. Obviously, we had the downturn in the first quarter. But, again, as I said earlier, it’s going to really come in two areas. One is what's funded from new production and then also where we start to see advances exceed payments. So as we see that pipeline build and those originations start to increase, that should result in getting us over the payoffs and turning into growth. But, again, as Bob mentioned in the beginning, we think that will be in the last second half of the year.

Will Jones, Analyst

Great. Okay. That’s helpful color right there. I wanted to also circle back just on the margin. I appreciate the new slides on the repricing slide. That’s really great. It really helps frame and visualize what would the fixed repricing opportunity is. And it really seems like, moving beyond 2025, there's still a pretty meaningful repricing story out there. But just curious today on new loans, where you're seeing pricing come in and what you're seeing from a competitive standpoint on loan pricing?

Ramon Vitulli, CRO

Yeah. Well, I mean, it is competitive for the good loan. So, but first quarter, our loan originations came on at a weighted average rate of 7.29%. And our renewed loans came on at 7.48%.

Will Jones, Analyst

Okay. And are you still sticking kind of within the same fixed versus variable SKU in terms of the broader it's really kind of more of a fifty-fifty mix?

Ramon Vitulli, CRO

Correct. On the new loans, what's coming on new.

Will Jones, Analyst

Okay. Great. And then just lastly for me. I mean, Paul, the expense story this quarter was really, you know, quite positive. I know we kind of talked about being more in that $295 million range for this year. I know it's not as simple as just analyzing what you guys did this quarter and there may be a little bit of timing differences with some costs that are coming through. But you just help us appreciate where you see expenses trending maybe into the next quarter and the balance of the year?

Paul Egge, CFO

Certainly. We work every day on expenses, and we would caution against annualizing the first quarter. Although, we have our notes to Crimestone as it relates to managing expenses, we want to be as thoughtful as possible about continuing to invest in the business and what's going to drive growth in a go-forward basis. So we look at this quarter as something we can hold our heads high with respect to and know, we like our chances of beating that prior guidance. But we will continue to see incremental investment while always holding the line where we can. Some of I probably got 50% of the relative beat there was on timing-related things that are likely going to come later in the month, particularly as it relates to professional services fees, and certain external audits and things along those lines that have to get done quickly. So not all of it will get pushed into the next year, but we are as diligent as we've ever been and we're very pleased with our performance on expenses year to date.

Will Jones, Analyst

Yeah. Okay. Great. Well, nice work there. Thank you for the questions, guys.

Operator, Operator

That concludes our Q&A session. I will now turn the call over to Robert Franklin, Jr. for closing remarks.

Robert Franklin, Jr., CEO

Very good. Thank you very much for joining our first quarter call. And with that, have a great weekend.

Operator, Operator

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