Stellar Bancorp, Inc.

over to Courtney Thurio. Please go ahead.

Thank you, operator, and thank you to all who have joined our call today. Good morning. Our team would like to welcome you to our earnings call for the fourth quarter of 2024. This morning's earnings call will be led by our CEO Bob Franklin and CFO Paul Ecke. Also in attendance today are Steve Wetzeloff, Executive Chairman of the company, Ray Vitulli, President of the company, and CEO of the bank, and Joe West, Senior Executive Vice 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 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 if it 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 .SellerBankClubEat.com for additional information about the risk factors associated with forward-looking statements. At the conclusion of our remarks, we will open the line and allow time for questions. I will now turn the call over to our CEO, Paul Franklin.

Thank you. Thank you, Courtney, and good morning to everyone. Thank you for joining us for the Stellar Bank Corp Fourth Quarter earnings call. I want to start by expressing my gratitude to the outstanding team at Stellar Bank. Their relentless efforts have laid a solid foundation that will support our journey as we grow into the future. As we move forward, our focus will be on growth. Our robust capital base and strong balance sheet coupled with the vibrant markets we serve pave the way for a promising future for Stellar Bank. With the election now behind us and interest rates stabilizing, we look ahead with optimism. Although we may not see significant relief in interest rates, the business environment remains favorable. We remain vigilant about inflation but continue to witness positive trends in job growth, population increasing, limited housing inventories, and an increased push for oil and gas production for both domestic use and export. These factors will serve as tailwinds we enter 2025. Our strategy remains clear. We will expand our relationship generated low-cost core funding base while broadening our loan offerings. Our commercial real estate portfolio remains well within regulatory guidelines allowing us to provide a full spectrum of loans to our customers. The capital we have built up over the past few years will support our organic growth, assist in potential partnerships, and provide the flexibility for share repurchases or increased dividends. For Stellar Bank 2025 is the year of the customer, internal, existing, and future. We will maintain a straightforward approach, grow our existing relationships, and cultivate new ones. We are eager to embark on this journey and excited for the year ahead. I'll now turn this call over to Paul Egge, our CFO, for more details on the quarter and the year.

Thanks, Doc. Good morning, everybody. We are pleased to report fourth quarter net income of $27.8 million or 52 cents per diluted share, which represents an annualized RLAA of 1.04 percent and an annualized RLATCE of 10.82 percent. And for the full year 2024, net income was $117.6 million or $2.20 per diluted share, which also represents an RLAA of 1.1 percent and an RLATCE of 12.18 percent. A key highlight of our fourth quarter performance was a continuation of net interest income progress after inflection earlier in the year. We look forward to seeing incremental improvement in 2025 on these fronts while we also seek to return to a reasonable level of growth in 2025. Thinking about 2024 as a whole, we have built a strong foundation from which to build upon while growing capital at a faster clip than much of the industry, de-risking our balance sheet, and protecting our earnings power, not withstanding the expensive increases that come from crossing the $10 billion asset threshold. Before moving on, I should note that the year-end size of the balance sheet benefited from certain seasonal increases in deposits and corresponding cash due to tax receipts from government banking clients during the last days of December, totaling over $300 million in -interest-bearing and interest-bearing checking deposits at year end. We expect these excess balances to normalize away during the

next quarter.

Net interest income for the quarter was $103 million, representing a slight increase from $101.5 million booked in the third quarter. This translated into a net interest margin of 4.25 percent in the fourth quarter relative to 4.19 percent in the third quarter. Purchase accounting accretion in the fourth quarter was $7.6 million relative to $5.8 million in the third quarter. Excluding purchase accounting accretion, tax equivalent net interest income increased slightly in the quarter to $95.5 million from $94.8 million in the prior quarter, and net interest margin was 3.94 percent on an adjusted basis, up from 3.91 percent in the quarter. Key drivers to the margin performance during the fourth quarter included strength in our -interest-bearing deposit portfolio, which at year end represented 39 percent of our deposit base, a 14-base point improvement in our cost of funds driven by a 19-base point improvement in our cost of interest-bearing liabilities. We also had higher securities yields and maintained strong yields after purchase accounting accretion. Walking further down the income statement, we booked a provision for credit losses on loans in the fourth quarter of $942,000. In combination with net charge drops during the quarter, this brings our allowance for credit losses on loans to $81.1 million, or 1.09 percent of loans, from $84.5 million, or 1.12 percent of non-interest income. We earned $5 million for the fourth quarter versus $6.3 million in the third quarter, while noting that that third quarter number benefited from $1.3 million of lumpy SBIC income and a small gain on sale of assets. Next, non-interest expense for the quarter was $72 million, up from the $71.1 million in non-interest expense for the third quarter. Non-interest expense for the full year 2024 was $285.7 million, up down from $290.5 million in 2023, but higher than our initial $280 million guidance in annual expenses for the year. Higher professional fees and outside operating expenses, severance expense and salaries were among the drivers of our expense story in 2024. For 2025, we expect modest growth in line with inflation of non-interest expense to about $295 million, although we are continuously seeking to hold the line where we can on expenses. 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 .06% at the end of the fourth quarter relative to .02% at the end of 2023 and .39% at the end of 2022. Since that first quarter end post-merger at the end of 2022, we have grown tangible book value per share .2% from $14.02 per share to $19.10 per share after dividends, representing a compound annual growth rate of .3% over the last two years. 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 fourth quarter, we did not repurchase any shares of our stock, but we did redeem the $40 million of bank-level subdebt in December. We will continue to evaluate share repurchases in 2025 not withstanding our preference to find more strategic uses of capital deployment like M&A. Entering into 2025, we really like where we sit both financially and strategically. It is our goal to deliver positive operating leverage during the year while we continue to manage through what we expect to be an improving operating environment for banks. We've laid the foundation to support adding more scale to the Stellar Bank platform, which will drive our ability to deliver more operating leverage as we create space from that $10 billion access threshold. Meanwhile, Stellar Bank will continue to seek to exploit our home field advantage in some of the best markets in the country. Thank you, and I will now turn the call back over to Bob.

Thank you, Paul, and we're ready for questions,

operator. At this time, I would like to remind everyone in order to ask a question, simply press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. And our first question comes on the line of Will Jones with KBW. Will, please go ahead.

Yeah, hey guys. Thanks. Good morning. Morning, Will. I just wanted to start on expenses. I know that, you know, that full year that came maybe a little bit ahead of where you were expecting to be, but broadly, you know, speaking of expenses, containment was still a pretty strong suit for you guys this year. I did want to ask about higher professional fees this quarter, whether there's, you know, anything to kind of reach into or anything kind of unique that was happening in that

line this year or this quarter? Now, it's timing related to certain outside auditing, outsourced auditing engagements.

Okay. And then, Bob, maybe just one for you, broader picture. You know, I read into your operating leverage comments in the press release. You know, I know, you know, kind of relative to your size, you know, presents kind of its own challenges. And, you know, you really need to see, you know, growth come back in earnest to see organic operating leverage. But to really kind of take that next step on profitability, do you feel like, you know, M&A needs to play a role for you guys? Well, I think

it really depends on speed. I mean, we can certainly get there faster if we can do M&A, but we don't want to make a big mistake. So, we're very calculating around how we go about seeking M&A partners. We can get there on an organic basis. It's just going to be a bit slower. And I think we'll continue to try to manage our expense level as we grow the bank. But we haven't focused on growth in the last couple of years. And this is a focus for us today. And we'll fight through some payoffs here probably early in the year. But I think we'll build momentum as we move into the first couple of quarters. So, we expect good things from an organic basis. But, you know, M&A is certainly out there because it would just help us get there a little quicker from an operating leverage standpoint.

Yeah,

okay. Last one, Paul, let's just jump into the margin real quick. I know in the past, you know, you kind of talked about, you know, relatively neutral from a, you know, rate positioning standpoint. I guess just, what would you just reaffirm that that's still how you are viewing it today? And as we look to 25, whether we see two cuts, three cuts, five cuts, just confirm maybe that you still see the same glide path to the margin as we kind of move to the balance of next year?

We sit in a great position of strength as relates to our margin. That we're really pleased with where it fits on an absolute basis and then as well when you adjust for per-sh accounting accretion. As long as we're able to maintain a core-funded balance sheet, which is really our goal, we see continued strength. Now, with respect to our positioning, we try to stay neutral and we're pleased with the fact that even if rates were to stay up high, we have, you know, continued repricing that should benefit us incrementally. That being said, we're big fans of an upward sloping yield curve. So, we kind of feel like we win no matter what. We're sitting in a great spot and we can withstand the current environment we think better than a lot of the industry.

Yeah, not a bad spot to be. Well, we're looking forward to 2025. Thanks, guys. Thanks, Will.

And your next question comes from the line of only with Stephen Smith. Please go ahead.

Hey, yeah, thanks. Good morning. Just want to clarify that the long growth outlook for 2025, I think back in October, we talked around a mid single digit growth for 25. And as you look at the pipelines and consider some of the paydowns that you referenced on the existing book, just want to see if that mid single digit level is still a reasonable goal for 2025.

I think that's still a good number. I think as we see some real estate payoffs around, people finally understanding that interest rates are probably going to stick around in this neighborhood for a while. We'll fight some payoffs at first, but then, you know, our goal is to get back to around that mid single digit. So, that's the plan.

Matt, we're I think you mentioned momentum and fourth quarter, long originations were the highest we've had in six quarters. So, we do have some momentum going into 25 and expect that to continue.

Okay, thanks for that, Ray. And then on the other side, on the deposit side, I think those deposit balances were relatively flat in 2024. Would love to hear a bit of thoughts on expectations to grow deposit levels in 2025?

Well, if you look at 2024, yeah, you're right about the number, but we really like the leading indicator of what we onboarded. So, we had 58% of our number of our accounts were new, of our new accounts were new, meaning the customers were not here before. And then we're watching those accounts as they grow, as they mature. So, and in dollar terms, our net new of was new exceeding closed was really strong. So, I think all those the leading indicators of where we're headed in 25 were good. We're continuing to onboard nice clients. And then on the loan side, we had some good CNI growth as a percentage of our originations, which helps our obviously helps our deposit proposition when we get those treasury accounts going with those loans.

Okay. All right. Appreciate that. And then just lastly, for me, going back to the comment about the goal of positive operating leverage for 2025, it looks like that guidance you gave us for expenses implies kind of a load of mixed single digit growth year over year. So, to get that positive operating leverage, should we be thinking about revenue growth in a manner similar to low to mid or a little bit higher? How are you thinking about the positive operating leverage comment?

You somewhat answered your own question. It's about 3% in growth and non-interest expense. And the revenue dynamics, we believe support that much higher on a higher base of revenue and that will deliver operating leverage as long as we can execute on incremental growth.

Okay. Thanks for the commentary,

guys.

Again, if you would like to ask a question, simply press star followed by the number one on your telephone keypad. And your next question comes from the line of Stephen Skauten with Piper Sandler. Stephen, please go ahead.

Yeah, thanks. Good morning, guys. Appreciate it. I guess if I could follow up one more question on that operating leverage, if I look at consensus numbers, it's maybe assuming earnings are down on a year over year basis and some of that provision related. But I'm just wondering, I guess, are you guys thinking about operating leverage core execution or are you thinking about that on a cap basis? And if so, what do you think analysts' expectations are kind of missing as it relates to that trend line?

We're seeking to deliver on both bases. And I think you guys will reset your expectations based on where our year end was and how we've delivered throughout 2024. It does feel like either the margin outlook or the combination of growth and margin has been relatively light. And we're seeking to be better clearly than what's out there in consensus numbers.

Got it. That's helpful. And then for that accretion, I think it was in the $47 million range in 23, 33 million, give or take this year. Would you expect that to kind of decline at a similar pace apart from obviously some unexpected paydowns and such? Is that the right way to think about it?

That's the right way to think about it. I mean, we've benefited from a decent amount of windfall earnings over the last two years in addition to what's scheduled accretion. We have currently remaining a loan discount of $73.7 million left. And we see it diminishing and flattening out in the next year or so.

Okay,

great. And then the deposit growth this quarter was pretty fantastic, especially some really strong non-inspiring deposit growth. And you paid down borrowing. So you guys have a ton of on balance sheet liquidity at this point. What do you start to do now that you've kind of tackled the borrowings? How do you think about the investments of that liquidity as you move forward, assuming the strength of your deposit base continues to shine through?

Well, we do need to note that part of that growth and year end balance sheet is going to be transitory relating to the seasonality of our operating account business in the government space. So that is when you pull that out, we're more flat on a quarter over quarter basis with respect to the overall deposit story. But we have, so that's the reason why there's a particularly high level of cash on the balance sheet, since we don't expect that funding to stay on our balance sheet for more than a month or so. So some of that excess liquidity is a mirage, but we do seek and we have been seeking to hold high level of securities and cash on our balance sheet. And we like that, so long as it's not at the detriment of our ability to drive a good earnings profile.

Okay, extremely helpful. And then just last thing for me is you talked about even I think even in the release, you guys noted the potential desire to partner and pursue some M&A. How do you think about the value of your currency at, let's call it around 150 a book and how that allows you guys to potentially pursue M&A or is that a hindrance that kind of current share levels?

Well, I think at this point, it's basically neutral. If you really look at it, it's not necessarily a benefit, but it's not necessarily a deficit, detriment either. We'd like to see it get higher. I think, you know, as we continue through the year and people get used to what we're doing, hopefully that'll improve. So we're going to seek to try to do that. But however, I think there's partners out there for us that understand our story and find us an attractive alternative to maybe what they're facing.

Got it. Very helpful. Thanks for all the time and congrats on closing out the year very strongly. Appreciate it.

Thank you, Stu. And your next question comes from the lineup, John Rodis with J.J. John, please go ahead.

Good morning, guys.

Paul,

maybe a question for you on the securities portfolio given, you know, your conversation just about deposit flows and outflows and then liquidity. How do you see securities portfolio trending in 25?

We like to keep our securities portfolio around -16% of our balance sheet. And we value the opportunity to consider increasing that. But we're really mindful of trying to drive the right overall return profile. And that, that I think is what drives that level currently.

OK. Thank you. Thank you, Paul. Helpful. And then just one other question on provisioning and I guess the reserve level and so forth. And I know Cecil plays a big part, but can you just talk about how we should view the provision for 25?

Credit has been great in 2024. And as we look at 2025, it is covering the waterfall of growth in loans relative to chargeoffs. And from a planning perspective, we assume a little bit more normalization in credit. But naturally, the last year in particular, we've benefited a ton from strong credit. And then there has been a measure of drivers in our reserve and partially a function of Cecil that has been very asset specific loans are individually evaluated. We're very conservative when something falls into that bucket. And to the extent that situation works itself out, it ends up creating a release situation. So there were a lot of idiosyncrasies there that drove our experience in 2024. We seek to continue to have strong credit in 2025. But we have normalized expectations and we'll continue to manage as best we can.

Paul, what do you think, you know, talking about normal, what do you think is sort of a normalized net charge off rate for your company?

Well, fortunately, we don't have a history of having high net charge off rates, either stellar or predecessor companies. But we do think it's prudent to have normalized expectations and this great run of credit in the nation is pretty long in the tooth. So we think where you guys are at in consensus around the teens, is it the right expectation to have and we'll continue to seek to continue our track record of driving better results and expectations tend to dictate.

Paul, just to clarify, is that mid-teens on net charge offs or is that mid-teens on provision expense?

Mid-teens on net charge offs, maybe 16 or so.

Okay, thank you guys. Have a nice day.

And your next question comes from the line of David Fister with Raymond James. Please, let's go ahead, David. Hey, good morning, everybody.

I just wanted to start on, you know, just the pulse of your economy, right, and what you're hearing from clients, right? I mean, Houston is seemingly one of the underappreciated markets in Texas. Texas is obviously doing extremely well. I just was hoping you could give us, you know, what are you seeing across your footprint and what are you hearing in the market?

Well, thanks, David, for the question because I do agree with you. I think Houston's underappreciated. We, the economics here in Houston are really good. I think if you think about it in terms of what the effect of interest rates were over the last couple of years, people needed to digest that. But I think the economy has allowed people to digest that in a pretty good way. So we haven't seen tremendous damage across the industry other than, you know, certain aspects of it, office buildings to be one, which is something we don't play a lot in, but it's been, has had its own damage. But for the most part, the resiliency of the economy here has allowed us to come through this crazy interest rate environment we've been going through the last couple of years in a pretty good way. So we feel good about where we are. As we look forward, we feel like we've got the wind behind us in a number of ways. With the administration that's changed, the regulatory environment we think is going to change a bit and the economy still rolling on, I do worry a bit about inflation, but for the most part, I think there's clear sailing for us. We haven't seen that in a while. And so with interest rates stabilized, I think people are able to make better decisions when they think they have a clear understanding of what that borrowing cost is going to be and cost to cap before. David,

we're waiting on year-end numbers, but we were trending towards population growth still in excess of 100,000, job growth still in excess of 60,000. And as Bob mentioned around rate stabilization, we're definitely seeing that with deal flow as far as what we're seeing in committee around just more opportunity there and more activity, I think, as Bob mentioned, because of the kind of stabilization in the rate environment. And we're winning business, which is great.

That's

great.

Markets definitely matter and you got a good one. And then just kind of maybe on the other side, with a really healthy economy, also that's where folks want to go. There's seen a lot of folks increase their focus on Texas. And I was just hoping you could touch on competition both for loans and deposits. It's always competitive. It's a tough market. It's extremely attractive market. But I'm curious, what do you see from the competitive landscape on pricing, structure, and again, on both loans and deposits?

Well, we said Houston taxes doesn't go unnoticed by the world. So we basically have every bank and financial institution in the world is right at our back door. So competition is something we're used to, David. I think what we're trying to sell to our customers is a very localized thing. And I think we found some good reception around the fact that if you look at the Houston market, JP Morgan still has 50% of the market. I mean, it's crazy. Something that was acquired back in the 80s. And to their credit, they haven't relinquished that. But our job is to kind of take some of that and I think that's kind of what we're focused on. And we now are at a size that we can basically make loans across the spectrum. Certainly not in competition with JP Morgan. But if you look at the top four banks in our markets, they're all very large institutions that have sort of soaked up that business over the years. And I think we can make incremental inroads into those guys. So we're going to continue to build our brand. And I think that's the thing that hasn't stood out yet, is that we need to continue to build our brand and get people to understand we're here and what the alternatives are to what they've had in the past.

And David, we've got, I mean, back to the momentum, we've got momentum there. I mean, over 50% of our new accounts, number of new accounts were the customers that had not been here before. So we really love that trend.

That's great. That's great. And what about from the hiring perspective, right? I mean, there's, you talk about a lot of folks coming into your market. You talk about larger banks and you guys gaining some share. What are you seeing on the hiring perspective? I know you guys have a good training program, but are you seeing opportunities to add new talent? Just curious what you're seeing. Because that's something that's always been a part of the bank is recruiting lenders. So just curious what you're seeing on that front.

Yeah. I mean, hiring is always competitive. I mean, a good lender around here with experience, it's going to be a competitive environment, especially as more people have a focus on C&I and we're seeing that out there. But our ODP program has been really fantastic in being able to provide us with young people that we can train from the ground up and let them hit the road with some direction from some of our old salts around here. And they've been very effective in gaining inroads into some really nice pieces of business. So as we build out our full spectrum from small business to C&I sort of lower middle market to even some corporate business, we're making inroads on all of those levels. And I think we'll continue to do that. And we're 24-7 looking for people that can help us build and grow this bank. So that's always top of mind and we'll continue to do that in the future.

That's great. Thanks, everybody.

Thank you.

There's no further question at this time. I will now turn the call back over to Bob Franklin for closing remarks.

Bob? Thank you, operator. And we appreciate everyone's interest in Stellar Bank and we'll conclude this call. Thank you.

This concludes the meeting. Thank you all for joining. You may now disconnect.