Stellar Bancorp - Q1 2024

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by, and welcome to the Stellar Bancorp, Inc. First Quarter 2024 earnings call. 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'd like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. I will now hand today's call over to Courtney Theriot, Chief Accounting Officer. Please go ahead.

Courtney Theriot (Chief Accounting Officer)

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 belief 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 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.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.

Robert R. Franklin (CEO)

Thank you, Courtney. Good morning, and welcome to the Stellar Bancorp first quarter earnings call. Excuse me. 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 roadmap of success. I will now turn over the call to Paul Egge, our CFO.

Paul Egge (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.

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. 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 non-interest income.

While not as large a portion of our revenue mix, non-interest income was a bright spot at $6.3 million for the quarter, thanks largely to nearly $500,000 gain on asset sales and some SBIC income in the quarter. Last, non-interest 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 our 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 ratios since the merger. Total risk-based capital was 14.60% 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 and tangible assets, and a loan discount of $98.2 million remaining. Our funding profile remains strong despite seeing our non-interest-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 a 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 area's extraordinary population gains.

I'll only add that the population growth stats 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.

Robert R. Franklin (CEO)

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

Operator (participant)

Thank you. If you would like to ask a question, press star one on your telephone keypad. If your question has been answered and you'd like to remove yourself from the queue, press star one again. We'll pause for just a moment to compile the Q&A roster. Your first question is from David Feaster with Raymond James.

David Feaster (Analyst)

Hey, good morning, everybody.

Robert R. Franklin (CEO)

Morning, David.

Ramon A Vitulli (President and CEO)

Morning.

David Feaster (Analyst)

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

Ramon A Vitulli (President and CEO)

Hey, David, it's Ray. So when you look at the first quarter that while we did originate, 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, you know, talks about this posture that we've had around loan origination. So you know, that level of 335 could generate low single-digit growth, but we're still seeing and what we believe to be healthy payoffs. We had $256 million of payoffs in the quarter.

So when you take that and, as you look at 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 for 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, you know, in that $300-$300 million or so plus range, it could still deliver low single digit. It just depends on, you know, where those fund and what happens if those payoff levels continue.

That 250, 256 for the quarter in payoffs is consistent with what we've seen really over the last five quarters in payoffs. So, and of those new loans booked, we felt really good around, 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 four or five quarters.

Joe F. West, Jr. (EVP and Chief Credit Officer)

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

David Feaster (Analyst)

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

Ramon A Vitulli (President and CEO)

Well, we still like what we're seeing 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 that, which isn't uncommon. Those business accounts usually don't start at a very high level. So, we're still onboarding solid accounts, and they're, of course, the NIB will take, and then on the interest-bearing portion, those came on at a. We're pleased with the rate that those came on compared to the portfolio. And, we're just still fighting the fight, you know.

When you look on the NIB, and you look that it did drop, there is a function of that, of where, where we had some broker deposits that, 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 carried, what we call that carried portfolio. So the decrease was not a function of some kind of outsized level of closed accounts.

David Feaster (Analyst)

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

Joe F. West, Jr. (EVP and Chief Credit Officer)

Yeah. This is Joe. In the non-accrual space, a good portion of that, about 60% of that, was comprised of two C&I credits that we are currently actively managing that have run into 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 were some couple of smaller construction loans that have run into problems, and we're you know, appropriately watching those and they were driven by some unexpected cost increases as well. So that's kind of the driver in that, and we also had two owner-operated CRE loans that ran into issues that we're dealing with.

So that comprises the, you know, $18 million jump in the NPAs that you see in the—reported in the Q.

David Feaster (Analyst)

Okay. Thanks for the color, everybody. Thank you.

Ramon A Vitulli (President and CEO)

Okay.

Joe F. West, Jr. (EVP and Chief Credit Officer)

Thanks, Dave.

Operator (participant)

As a reminder, to ask a question, press star one on your telephone keypad. Your next question is from the line of Matt Olney with Stephens.

Matthew Olney (Analyst)

Hey, thanks. Good morning, everybody.

Joe F. West, Jr. (EVP and Chief Credit Officer)

Morning, Matt.

Matthew Olney (Analyst)

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. Thanks.

Ramon A Vitulli (President and CEO)

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, of all, 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 643 + 328.

Now, there's a funding component of that, that's the note amount, but I think that gives you kind of the range of what we're talking about with that, you know, close to, what's that? $1 billion between new and renewed with an eight handle.

Matthew Olney (Analyst)

Yeah. Okay. That's helpful. And then I guess just following up with that, love to hear from maybe a credit perspective, you know, 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?

Joe F. West, Jr. (EVP and Chief Credit Officer)

Yeah, Matt, as we had conversations with the borrowers about that, they've known that if they've got a maturity coming up, that the rate's gonna be higher, and, they've been accepting of that. You know, we have a lot of good guarantor support in our, in our loan portfolio, and so the guarantors have stepped up when it's been necessary for them to do that. But for the most part, and I would say there hasn't been much pushback, at all about, you know, not being able to afford that. They, they know this is coming, and, we've been, you know, 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.

Robert R. Franklin (CEO)

Yeah, and Matt, with the dynamics that are going on in Houston, the ability to still price up on leases is still out there, with 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 got to get through a lease cycle, so that's where we're trying to bridge the gap with folks to get from one 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 onto the market, so these guys are in pretty well positioned to be able to increase rates set 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 we get additional collateral pay downs, but, the market is helping us, along with the borrowers themselves.

Matthew Olney (Analyst)

Okay, appreciate that. And then, I guess, from the 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?

Paul Egge (CFO)

Sure thing. I mean, we're fighting battles on a couple fronts. First, it's overall cost of interest 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.

Matthew Olney (Analyst)

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?

Paul Egge (CFO)

Certainly. Well, we're focused on liquidity, as you heard Bob and I mention in our prepared remarks. And building liquidity through our securities portfolio has incrementally 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 so paramount, we're getting 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 by-product of that build in the portfolio.

Matthew Olney (Analyst)

Okay, guys. That's all for me. Thank you.

Joe F. West, Jr. (EVP and Chief Credit Officer)

Thanks, Matt.

Robert R. Franklin (CEO)

All right.

Operator (participant)

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

John Rodis (Analyst)

Hey, good morning, guys. Just to follow up on Matt's question on the securities portfolio. Paul, would I, I guess directionally, would you expect it to remain relatively stable going forward, or how should we think about that?

Paul Egge (CFO)

You know, 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 incremental ways to go before we kind of read the tea leaves as to how we want to manage our balance sheet. But that is an interim target for us.

John Rodis (Analyst)

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

Paul Egge (CFO)

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.

John Rodis (Analyst)

Okay. 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?

Paul Egge (CFO)

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

John Rodis (Analyst)

Okay. And then, Paul, just on expenses, you know, $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, with that range? Maybe a little bit higher, just given the first quarter run rate.

Paul Egge (CFO)

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 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.

John Rodis (Analyst)

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. I guess that's what you're saying?

Paul Egge (CFO)

I see a decent chance that we'll have pressure on that 280 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 broader other initiatives that have the potential to put pressure on guidance.

John Rodis (Analyst)

Okay. Okay. Thanks, guys.

Joe F. West, Jr. (EVP and Chief Credit Officer)

Thanks, John.

Operator (participant)

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.

Robert R. Franklin (CEO)

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

Operator (participant)

This concludes today's call. Thank you for joining. You may now disconnect your lines.