STEL - NASDAQ

Ladies and gentlemen, thank you for standing by, and welcome to the Stellar Bancorp, Inc. First Quarter 2024 Earnings Call. [Operator Instructions] I will now hand today's call over to Courtney Theriot, Chief Accounting Officer. Please go ahead.

Good morning. Our team would like to welcome you to our earnings call for the first quarter of 2024. This morning's earnings call will be led by our CEO, Bob Franklin; and CFO, Paul Egge. Also in attendance today are Steve Retzloff, Executive Chairman of the company; Ray Vitulli, President of the company and CEO of the bank; and Joe West, Senior Executive Vice President and Chief Credit Officer of the bank. Before we begin, I need to remind everyone that some of the remarks made today constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 as amended. We intend all such statements to be covered by the safe harbor provisions for forward-looking statements contained in the act. Also note that if we give guidance about future results, that guidance is only a reflection of management's beliefs at the time the statement is made, and such beliefs are subject to change. We disclaim any obligation to publicly update and any forward-looking statements, except as may be required by law. If you 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.

Thank you, Courtney. Good morning, and welcome to the Stellar Bancorp first quarter earnings call. The Stellar Bank team remains focused on building the Stellar way. Thank you to all the Stellar team members for continuing your efforts to strengthen our bank and create shareholder value. . Our aim has not moved as we continue to build capital, strengthen liquidity and closely watch our credit. We are a community bank that is our heritage and our culture. We work with our customers as they work with us. Higher interest rates have put a strain on existing cash flows on certain projects, depending on the timing of underwriting. We continue our efforts to identify potential challenges early. As with new projects, we look to guarantor support additional collateral and/or paydowns as we work with our customers to get through the project cycle. Our intent is to stay close to our customers and closely watch those credits. We intend to stay well reserved in the event we need to address stress. As we work with our customers and identify stress, we may see our classified list expand a bit, but it does not appear that the ultimate stress level will result in significant losses. The requirement of significant equity going into a project or the paydown over the years has allowed us to exit credits without the losses that might otherwise be expected. Our customers are also bolstered by our good markets, holding asset values and a significant amount of capital chasing deals. Houston saw our population grow by almost 140,000 people last year, second only to Dallas Fort Worth. We created over 100,000 new jobs last year. Our future is bright, and we operate in one of, if not, the best markets in the United States. We maintain a great deposit base, have good liquidity, strong capital and good credit metrics. We understand what we need to do as the Federal Reserve fights inflation with higher interest rates. Our intention is to stay focused on the fundamentals of our road map of success. I will now turn over the call to Paul Egge, our CFO.

Thanks, Bob, and good morning, everybody. We are pleased to report first quarter net income of $26.1 million or $0.49 per diluted share, which represents an annualized return on average assets of 0.98% and an annualized return on average tangible common equity of 11.47% as compared to fourth quarter earnings of $27.3 million or $0.51 per diluted share, which made for an ROAA of 1.02% and a return on tangible common equity of 12.61%. As Bob mentioned in his commentary, we are continuing our focus on capital, liquidity and credit in 2024. So as it relates to balance sheet management, this means that we have been taking a defensive posture, putting a lower emphasis on loan growth and a higher emphasis on optimizing asset and liability composition, building liquidity, maintaining a neutral interest rate risk position and accruing capital. And on the earnings front, we are doing our best to protect earnings power, notwithstanding pressures from the current interest rate environment and managing the responsibilities that come from having crossed the $10 billion asset threshold. Net interest income for the quarter was $102.1 million, representing a decrease of $3.8 million from the $105.9 million booked in the fourth quarter of 2023. Most of this difference can be attributed to purchase accounting accretion decreasing $3.2 million relative to the prior quarter. This translated into a net interest margin of 4.26% in the first quarter relative to 4.4% in the fourth quarter of 2023. Excluding purchase accounting accretion, net interest margin was unchanged from the linked quarter at 3.91%. Walking further down the income statement, we booked a $4.1 million credit provision in the quarter versus about $1 million in the prior quarter, largely reflective of appropriately conservative reserving for potential problem credit. Since annualized net charge-offs were very manageable at only 4 basis points of average loans, this provision puts our allowance for credit losses up to 1.22% of total loans from 1.16% in the prior quarter. Moving on to noninterest income. While not as large a portion of our revenue mix, noninterest income was a bright spot at $6.3 million for the quarter, thanks largely to nearly $0.5 million gain on asset sales and some SBIC income in the quarter. Last, noninterest expense for the quarter was in line with our expectations at around $71.4 million, which reflects certain seasonal dynamics, such as annual merit increases and a seasonal uptick in payroll taxes from bonus payments. We remain focused on managing expenses as effectively as possible while also managing investments in the infrastructure necessary to operate above the $10 billion threshold. Given cumulative industry pressures, we feel good about our results, our ability to protect earnings power relative to the industry and our positioning for the future. As it relates to capital, we've been very successful growing our regulatory capital ratio since the merger. Total risk-based capital was 14.62% at the end of the first quarter relative to 14.02% at the end of 2023 and 12.39% at the end of 2022. This progress has been consistent across all regulatory capital ratios and is reflective of our tangible book value growth since closing the merger. Relatively strong earnings, notwithstanding accelerated amortization of CDI expense has been a really solid driver to our internal capital generation since the merger, and we like our prospects for continued internal capital generation. On the topic of purchase accounting items, we ended the quarter with $110.5 million in core deposit intangible assets and a loan discount of $98.2 million remaining. Our funding profile remains strong despite seeing our noninterest-bearing deposits fall below the 40% threshold, but it highlights the extent to which funding mix impacts our business. This has the potential to be somewhat of a drag on go-forward net interest margin, but we remain bullish on our ability to continue to compare favorably in the industry on NIM and the value of our strong deposit franchise in the Houston region. Speaking of Houston, Bob mentioned the 2023 data on the Metropolitan areas extraordinary population games. I'll only add that the population growth staff of Houston and Dallas in 2023 are notably far ahead of the pack relative to the most populous metro areas in the U.S. in both absolute value and percentage terms. Key drivers continue to be jobs and relative affordability. So the overall strength of the markets we serve and our strategic positioning gives us further comfort in Stellar's potential for success in 2024 and beyond. Thank you. And I will now turn the call back over to Bob.

Thank you, Paul. And operator, we're ready to take questions if there are any.

[Operator Instructions] Your first question is from David Feaster with Raymond James.

Maybe let's start with loans. I'm curious some of the drivers behind the decline in loan balances. I mean we talked about a slower pace of growth, but I was curious maybe if your appetite for credit has changed or demand has weakened. And just any color on how the pipeline is trending and expectations for growth? And maybe what you're hearing from your clients more broadly?

David, it's Ray. So when you look at the first quarter that while we did -- we originated about $335 million of new loans, up a little bit from the fourth quarter, but kind of in line with the quarter prior to that, which really talks about this posture that we've had around loan origination. So that level of $335 million could generate low single-digit growth, but we're still seeing what believe to be healthy payoffs, we had $256 million of payoffs in the quarter. So when you take that and our -- as you look at our -- where we've -- what we've done around construction development lending, where we're really in that, what we call the carried piece, we're not getting the lift of where you would have advances exceeding payoffs like we had in the past. So that's really bringing nothing to the loan growth piece because it's about equal. So it's really a function of what are those new loans fund at and what is our payoff experience. So that's really what drove the net decrease. I think in that $300 million or so plus range, it could still deliver low single digit. It just depends on where those fund and what happens if those payoff levels continue. That $250 million -- $256 million for the quarter and payoffs is consistent with what we've seen really over the last 5 quarters in payoffs. So -- and of those new loans booked, we felt really good around the -- where those are coming in pricing-wise. Those new loans came on at [ $8.49 ], which is really a high level mark when you look over the past 4 or 5 quarters.

[indiscernible] we do have some stricter underwriting around a lot of this and so I think that's slowed the pace a little bit. And then just higher interest rates, I think, has slowed demand a bit. So a combination of all of that, there's still business out there, but it is slower than it has been.

Okay. That's helpful. And then maybe just touching on the other side with core deposit trends, especially on the NIB front. How did that trend throughout the quarter? Was that front-end or back-end weighted in? Just could you touch on your core deposit growth initiatives and where you're having success, especially just kind of thoughts on how you think about NIB trends as well?

We still like what we're seeing on the -- on our new account onboarding. It still looks to support that kind of the NIB that we've historically maintained. Our number of accounts were really good in the NIB category. Just our dollar was a little less than previous quarters and the dollar amount associated with that, which isn't uncommon. Those business accounts usually don't start at a very high level. So we're still onboarding solid accounts in the -- of course, the NIB will take. And then on the interest-bearing portion, those came on at -- we're pleased with the rate that those came on compared to the portfolio. And we're just still fighting the fight. When you look on the NIB, you looked at it did drop, there is a function of that of where we had some broker deposits that took an impact -- that had an impact on the NIB. When you look at the book without that, it's still -- we still like where that sits. Also, just to point that decrease mostly came in that -- what we call that carried portfolio. So the decrease was not a function of some kind of outsized level of closed accounts.

Okay. Okay. That's good color. And then maybe just touching on asset quality more broadly. You guys have a great reputation as being a very conservative underwriter, quick downgrade, slow to upgrade. I'm curious what you're seeing on credit more broadly, if you could touch on what drove the increase in nonaccruals? And just kind of what you're seeing perhaps more broadly on the credit front?

This is Joe. In the nonaccrual space, a good portion of that, about 60% of that was comprised of 2 C&I credits that we are currently actively managing that have run in some management issues and experienced some problems. So we're actively managing those. So that drove most of that increase. In a couple of isolated cases, there are some couple of smaller construction loans have run into problems, and we're appropriately watching those and that was driven by some unexpected cost increases as well. So that's kind of the driver in that. And we also had 2 older operated CRE loans that rated issues that we're dealing with. So that comprises the $18 million jump in the NPAs that you see in the report and in the Q.

[Operator Instructions] Your next question is your line of Matt Olney with Stephens.

I want to ask about core loan yields. We saw some nice positive movements in the loan yields ex the accretion. Just remind us of your fixed and variable rate loan repricing schedule that's coming up? And just any more color on those recent levels that you've been receiving as far as newer loan yields? And just any kind of commentary on kind of core loan yield outlook from here?

Matt, I'll give you just a little bit of color there on -- so on the new loans, as I mentioned, $330 million came on at [ $8.49 ] is the note rate. And then really on the repricing opportunity, I'd probably just describe it in the amount of loans that renewed in the quarter, just evolve whether fixed or variable. And that was mentioned before, we typically renew around $600 million a quarter. It was $643 million for the first quarter, and that renewed at [ $8.05. ] So if you kind of think about what's coming on with market new pricing, it was [ $6.43 ] plus [ $3.28. ] Now there's a funding component of that. That's the note amount, but I think that gives you kind of some -- the range of what we're talking about with that close to was that $1 billion between new and renewed with an [indiscernible]

Yes. Okay. That's helpful. And then I guess just following up with that, love to hear from maybe a credit perspective. As you renew those loans at higher levels, just how that's being digested with some of the borrowers with higher debt expense? I don't know if Joe or anybody else has any views on just the discussions with those borrowers digesting that?

Yes, Matt, as we had conversations with our borrowers about that, they've known that if they've got a maturity coming up that the rate is going to be higher, and they've been accepting of that. We have a lot of good guarantor support in our loan portfolio. So the guarantors have stepped up wouldn't been necessary for them to do that. But for the most part, I would say there hasn't been much pushback at all about not being able to afford that. They know this is coming, and we've been working with them and the move up in the rates that they're paying that they fully understand that and have been able to absorb it.

Yes. And Jeff -- Matt, with the dynamics that are going on in Houston, the ability to still price up on leases is still out there, the exception of office, which we're not talking about office, but for most of the stuff that we have, there's still ability to increase rates. Now they've got to get through a lease cycle. So that's where we're trying to bridge the gap with folks to get from 1 lease cycle to the next so that they can increase those rates and move on. We still have rate increases. There's not a huge amount of stuff coming on to the market. So these guys are pretty well positioned and be able to increase rates on their tenants when they get the opportunity, but they got to get the opportunity. So we actually feel good about our position. We've got guarantors that can bridge the gap there, sometimes to get additional collateral paydowns. But the market is helping us along with the borrowers themselves.

Okay. Appreciate that. And I guess from an overall perspective of the net interest margin, obviously, you've got the headwind of the deposit costs, offset by this core loan yield dynamic going the other direction. Paul, I'm curious kind of what your thoughts are on the core margin from here?

Sure thing. I mean we're fighting battles on a couple of fronts. First, overall cost interest-bearing deposits, deposit mix shifts as well as this uptick in nonperformers on the loan revenue side hits us from the other end. So we feel good about our positioning as it relates to maintaining a relatively strong margin, but we definitely see pressure in the second quarter relative to where we were in the first quarter.

Okay. And then just lastly, on the investment security side, it looked like there was a nice step up of the overall balances from 4Q into 1Q. Any color on that step-up? And specifically, from your recent purchases?

Certainly. Well, we're focused on liquidity, as you've heard Bob and I mentioned in our prepared remarks and building liquidity through our securities portfolio has incrementally has been something that we've been trying to be thoughtful about. The types of securities we're going into are largely cash flow-oriented since liquidity is paramount when getting a high level of principal back from the standpoint of cash flows from that overall securities portfolio. We think we'll be able to post better yields in the go forward as a byproduct of that build in the portfolio.

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

Just a follow-up -- just to follow up on Matt's question on the securities portfolio. Paul, would -- I guess, directionally, would you expect it to remain relatively stable going forward? Or how should we think about that?

We're on a path of trying an intermediate target of getting to securities as a percentage of assets of more like 15%. We're at about 14.2% currently. So we've got just a little bit of incremental ways to go before we kind of read the tea leaves to how we want to manage our balance sheet, but that is an interim target for us.

Okay. On the fee income side in other income, what was the SBIC impact this quarter?

I believe it was around $400,000. So we can't necessarily set our watch to when we get some SBIC income, but we have a diversified range of investments and when -- we welcome it when it comes.

Okay. And so other income was $3.1 million for the quarter, back out that $400,000, was there anything else unusual or of size this quarter in that other line item?

Actually, the gain on sale is, obviously, separate from other income, but the gain on sale as we called out before was kind of the largest unusual item. There may have been a couple of smaller items that added up to that being higher than expected [indiscernible].

Okay. And then, Paul, just on expenses, 71 -- $71.4 million for the quarter. I think last quarter, you talked about sort of for the year around $280 million or so. Do you still feel comfortable with that range, maybe a little bit higher just given the first quarter run rate?

Well, the first quarter was very much aligned with our plan because we are -- we did expect some seasonal dynamics to make the first quarter be relatively larger. But as we go forward in 2024, we do see potential for some projects to perhaps put pressure on the [ $280 million ] guidance we gave last week -- last quarter, but we're working hard really to manage and how we, ultimately, get the expense levels for our combined company right in the go forward. There you have it.

Okay. So Paul, I guess, said another way, I mean, I guess, this first quarter run rate is probably a better -- I mean, so you come in a little bit above [ $280 million ]. I guess that's what you're saying?

I see a decent chance that we'll have pressure on that [ $280 million ] guidance. The first quarter actually isn't as indicative of that just because we literally hit the nail on the head as it relates to our plan. We expected expenses to be a little more swollen for seasonal reasons here in the first quarter. It's more broad or other initiatives that have the potential to put pressure on guidance.

At this time, there are no further audio questions. I will now hand today's call back over to Mr. Franklin for any closing remarks.

Thank you very much. Appreciate everyone's interest in Stellar Bank today, and thank you for being on the call.