Stellar Bancorp - Earnings Call - Q3 2025

Executive Summary

• Q3 2025 delivered resilient profitability: diluted EPS of $0.50, with a slight EPS beat vs S&P Global consensus ($0.494*) and a modest revenue miss ($105.3M* vs $106.1M*) as NIM ticked up to 4.20% (4.00% ex-PAA) and net interest income rose sequentially. Results were supported by core deposit growth (+$143.8M QoQ) and stronger capital (Total capital ratio 16.33%).
• Operating costs were elevated (noninterest expense +$3.1M QoQ; efficiency 63.69%), including ~$.5M severance tied to two planned branch closures; management guided that Q4 expenses should be closer to the 1H run-rate (~$70M).
• Credit remained manageable though net charge-offs rose to $3.3M (0.18% annualized); NPLs/loans eased to 0.65% and NPAs/assets to 0.51%.
• Potential stock reaction catalysts: sustaining ~4% NIM ex-PAA amid rate cuts, visible deposit momentum (51% of new deposits from new-to-bank clients), expense normalization in Q4, and capital actions (Oct 1 redemption of $30M sub debt).

Note: Estimates marked with an asterisk (*) are values retrieved from S&P Global.

What Went Well and What Went Wrong

• What Went Well

  • NIM and core NIM improved: 4.20% total NIM (tax-equivalent) and 4.00% ex-PAA vs 4.18%/3.95% in Q2; CFO: “We’re really proud to get NIM, excluding purchase accounting accretion, back to a 4% level”.
  • Core funding momentum: deposits +$143.8M QoQ with noninterest-bearing mix ~36.4% and focus on low-cost funding; CEO emphasized priority on low-cost deposits.
  • Capital build/TBVPS accretion: Total capital ratio 16.33% (↑35 bps QoQ); TBVPS rose to $21.08; subsequently redeemed $30M subordinated debt on Oct 1, strengthening flexibility.

• What Went Wrong

  • Loan balances fell $119.5M QoQ (to $7.17B) on elevated payoffs ($330M in Q3, ~$50M higher QoQ) and continued portfolio repositioning.
  • Expenses stepped up: noninterest expense +$3.1M QoQ to $73.1M; efficiency ratio worsened to 63.69% (from 61.87% in Q2); included ~$.5M severance tied to planned branch closures.
  • Credit costs rose: net charge-offs increased to $3.3M (0.18% annualized) vs 0.01% in Q2, though management cited these were spread across >10 relationships and largely reserved for already.

Transcript

Operator (participant)

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 Theriot, Chief Accounting Officer. Please go ahead.

Courtney Theriot (Chief Accounting Office)

Thank you, Operator. 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, Robert 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 Bank, and Joe West, Senior Executive Vice President and Chief Credit Officer of Bank. Before we begin, I need to remind everyone that some of the remarks made today constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 as amended. We intend all such statements to be covered by the safe harbor provisions for forward-looking statements contained in the Act.

Also note that if we give guidance about future results, that guidance is only a reflection of management's beliefs at the time the statement is made, and such beliefs are subject to change. We disclaim any obligation to publicly update any forward-looking 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.

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 bankers' emphasis on getting the full client relationship. Credit 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 Egge, 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 per diluted share, as compared to net income of $26.4 million or $0.51 per diluted share in the second quarter. These represent an annualized ROA of 0.97% and an annualized ROATCE 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. 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 and 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 the third quarter was $4.8 million, down from $5.3 million in the second quarter. 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 NIM, 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 provision. For a year-to-date perspective, our net charge-offs totaled $3.7 million, or approximately 7 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 million of write-downs on foreclosed assets and other 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 $0.5 million, 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.

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 and 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 were 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 have built a strong balance sheet that can support quality growth, and with growth, we are 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 turn the call back over to Bob.

Bob Franklin (CEO)

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

Operator (participant)

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 one 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 (Director)

Hey, good morning, everybody.

Bob Franklin (CEO)

Morning.

David Feaster (Director)

I just wanted to start on, let's start on the growth side. I know somewhat of the 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, what's driving the payoffs and paydowns? How much of that is competition versus just asset sales and those kinds of things? How do you think about the growth outlook as we look forward? I mean, Texas is a very competitive market on one hand, and 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 take in that all together. How do you think about growth and just any insights you can provide on that?

Ray Vitulli (President of the Company and CEO of Bank)

Yeah sure David. Yeah, so I'll start maybe a little bit with what's impacting the growth when we talk about the payoffs, like you asked, the color around that. Payoffs this last quarter were about $50 million more than the previous quarter. We've talked about a run rate of around $300 million of payoffs. They were $330 million in the last quarter. Year to date, about 44% of our payoffs are related to sale of collateral, sale of business. About 25% is in that competitive area of refinance elsewhere. 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. Some of that will go away. On that refinance elsewhere, 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, and the waterfall is, we've talked about it before, but we call it carried, which is our advances versus our paydowns and scheduled payments. As Paul mentioned, we have a reserve related to unfunded that continues to grow, but we're still not seeing the lift from that. Compared to the previous quarter, that was almost another $50 million of increase in payments and paydowns exceeding the advances. 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. Last third quarter, we originated almost $500 million of loans compared to $640 million the previous quarter.

The real thing that I think we want to make sure we communicate is just overall year to date, compared to last year's first three quarters, we're up 62% of loan originations and in the mix that we like with a little bit more C&I in that mix. Things are heading in the right direction. We just have to continue to convert on our pipeline, and the pipeline remains healthy. I think the little bit of the originations that were down compared to the previous quarter were 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. The pipeline remains healthy, and we're really pleased with where we stand there.

David Feaster (Director)

That's great. Maybe touching on the credit side a little bit, concerns are, 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? Secondarily, I was just hoping you could maybe touch a bit on your approach to credit, collateral management, stress testing, ongoing monitoring. It seems like some of those are what investors are concerned about in the industry. I was hoping you could elaborate maybe a little bit on your process and your approach to managing credit.

Bob Franklin (CEO)

Yeah, I think the best way to manage credit is when they come in through the front door, David. I mean, that's how we manage credit most of the time. However, we do stress testing. We do all the things that folks do to monitor portfolios. 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%-100% loan to deposits. We're now down about in the low 80% 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.

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. 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 real estate continues to be a good active place for us to put money. I think we would be more concerned if we were in a less dynamic market. We're in a very dynamic market. All the things that are affecting the world, for that matter, with 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, Wilmot.

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 (Director)

Okay. That's helpful. I just wanted to maybe switch gears to the deposit side. I mean, your growth was really strong this quarter. Cost decline. I just wanted to get a sense of some of the drivers behind that. How much of that is new clients versus increasing the liquidity or relationships with existing clients? With the liquidity build, even after paying down borrowings and buying a little bit of securities, I'm just kind of curious what your plans are for some of that excess liquidity going forward.

Ray Vitulli (President of the Company and CEO of Bank)

Yeah, David, I'll touch on, let me touch real quick on the deposits, on the deposit growth piece. Really pleased there, as we've already mentioned. Of our new deposits that were onboarded in the quarter, 51% were to new customers that have not been here before. We've seen that kind of hover in that 40%-50% all year, which we really like. 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. 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 represents that other 50%.

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. Our 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. 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. We want to grow the loan portfolio. We want to, that's where we grow customers, and that's how we continue to grow the bank. It's important to us to continue on that line. A lot of turmoil in our markets, a lot of M&A going on, 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 also had 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. We're not going to join that party. That one doesn't fit us. If we have to retreat a little bit, we'll do it. 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. If we continue to do the right things, which I think we are from a customer acquisition standpoint, we'll continue to, we'll grow the bank. That's kind of how we're approaching it.

David Feaster (Director)

That's helpful. Thanks, everybody.

Bob Franklin (CEO)

Thanks, David.

Operator (participant)

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

Stephen Scouten (Managing Director)

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 with some of our government banking deposits. In fact, this last year, we had about a $200 million deposit that came in on 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 y'all just how much represents what we would call seasonal excess. 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 January and February, and it's kind of gone by March.

Sometimes, and last year was a great example, sometimes it comes in right before the end of the year.

Bob Franklin (CEO)

That is not reflected in this quarter's deposit growth. It doesn't happen until late in the fourth quarter on those government deposits.

Paul Egge (CFO)

Precisely.

Stephen Scouten (Managing Director)

Perfect. Great. That's great color. When you were talking a little bit about the expense ratio, saying it looked like you know 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 and salaries, what makes this an outlier? Do you think that kind of $70 million range is a level you can hang around in 2026, 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 or first half run rate than what we posted in the third quarter. It might not be just as great as the $70 million per quarter we were posting in the first half of the year, but definitely closer to that than the $73 million we posted in the third quarter. Separately, we will see some inflation. 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. We feel really good about where we sit, and you know the goal is to continue optimizing and holding the line as much as we can going into 2026 and beyond.

Operator (participant)

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

Will Jones (Associate VP and Equity Research Analyst)

Hey, great. Thanks. Good morning, guys.

Paul Egge (CFO)

You're welcome.

Will Jones (Associate VP and Equity Research Analyst)

Hey, so Paul, maybe we could just stick with you and move into the margin discussion. I mean, if you exclude purchase accounting, we've kind of hit that 4%, and that felt like kind of the overarching near-term target for you guys. 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. As we think about this next period of Fed easing, will that ability to defend, will that really be more of just some tailwinds from fixed-through pricing, or do you intend to be relatively aggressive lowering deposit costs from here?

Paul Egge (CFO)

You know, 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. We feel really good about kind of the initial repricing dynamics. Separately, there are some tail trends that are helping us in how our securities and loans reprice. We're still in a kind of a pretty good backdrop to defend that margin. As the deck gets reshuffled at every rate cut, there could be some timing distinctions. We feel like we've got the benefits are likely to sufficiently mitigate the drawbacks of how those reprices go on. We're feeling good about defending it.

Actually, we're pleasantly surprised to have gotten to the 4% net interest margin, excluding purchase accounting accretion, as fast as we did. We certainly did not promise that to the market and did not expect it necessarily 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 (Associate VP and Equity Research Analyst)

Yeah. What well done there. Could you just remind us, is there a kind of a terminal interest bearing deposit beta that you guys are trying to manage 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. Just like on the upswing where we didn't, we weren't as aggressive in necessarily moving a lot of our kind of base sheet rates, we're more focused on, okay, how do we manage this exception population and what we in this index population? How do you really manage your most price-sensitive customers on the deposit side? We're going to continue to do that on the way down. 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. That's all a reasonable ask.

It so far has functioned pretty well in the September rate cut. We'll follow the same game plan as we go forward.

Will Jones (Associate VP and Equity Research Analyst)

Okay. Maybe to follow up, as you know, we've talked about deposits and the growth that's happened there and kind of the excess liquidity that you have as a result. If we do continue to fight the paydown bug a little bit and to the extent loans don't really ramp up in growth meaningfully in the near term, could you look to be a little more opportunistic, adding to the bond book from here?

Paul Egge (CFO)

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. 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. We are very pleased to be having a very healthy and strong balance sheet.

Will Jones (Associate VP and Equity Research Analyst)

Yeah. Okay. Fair enough. That's it from me, guys. Thank you.

Paul Egge (CFO)

All right. Great.

Operator (participant)

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

Matt Olney (Research Analyst)

Thanks. Good morning. I wanted to circle back on the loan growth discussion. 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. Just curious what your expectations are as when we could see this pressure ease up. Thanks.

Ray Vitulli (President of the Company and CEO of Bank)

Hey, Matt. One of the things that we will get a lift from is our advances exceeding our paydowns and payments. When you go back and look at our history of when we were getting a lift, it patterns, kind of, this matches up with our loan origination. As we said, loan originations are up 62%. We will get some lift there, whether that's, we may be a couple of quarters away from that helping us and not taking away from loan growth. 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-$350 million of payoffs that we have.

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. 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. Again, our pipeline's healthy. If we're in this, like last quarter, $600 million of origination, that's getting us closer to where that will give the fundings, even with the payoffs, to get us. As you know, last quarter, we had a slight gain and or slight increase in net funded loan balances. It's just a matter of delivering on that pipeline and continuing on the path that we've seen in the last couple of quarters and really year to date. We said before that we thought growth would manifest in the second half of the year.

Of course, we still have the fourth quarter, but going into 2026, we feel good that we will pivot to that.

Matt Olney (Research Analyst)

Okay. Appreciate that, Ray. I also 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 Stellar Bank. Thanks.

Bob Franklin (CEO)

Yeah, Matt. We continue to have conversations. We talk to a lot of folks. I think you've seen some transactions that we'd have some interest in and some not. 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. As we look at partners out there and how they've structured their funding, it would not behoove us to join somebody that takes away from the funding base that we have just to be larger. What we want to do is make sure that we find the right partners that think about the world the same way we do and fund themselves in a similar fashion. We continue to have conversations.

I think there's a possibility that we can be active in this space, but we're going to be careful about how we approach it.

Matt Olney (Research Analyst)

Okay. Thanks for the commentary and agree. It's a high-class problem to have protecting the balance sheet. Lastly for me, I guess over to Paul. Paul, I heard you mention the purchase accounting accretion in prepared remarks. I'm looking for the updated fair value mark on that portfolio.

Paul Egge (CFO)

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

Matt Olney (Research Analyst)

Perfect. Okay, guys, thanks for your help.

Paul Egge (CFO)

Thanks, man.

Operator (participant)

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. With that, we are adjourned.

Operator (participant)

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