Stellar Bancorp, Inc.

over to Courtney Trio. 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 Redsloff, 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 provision 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 any forward-looking statement, especially if it is 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.sellerbanklookinc.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, 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, paved 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 as 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% and an annualized RLATCE of 10.82%. And for the full year 2024, net income was $117.6 million, or $2.20 for the chair, which also represents an RLAA of 1.1% and an RLATCE of 12.18%. A key highlight of our fourth quarter performance with a continuation of net interest margin and 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, notwithstanding 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 non-interest bearing and interest bearing checking deposits at year end. We expect these excess balances to normalize away during the first quarter. Net interest income for the quarter was $103 million, representing a slight increase from the $101.5 million booked in the third quarter. This translated into a net interest margin of 4.25% in the fourth quarter relative to 4.19% 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% on an adjusted basis, up from 3.91% in the prior quarter. Key drivers to the margin performance during the fourth quarter included strength in our non interest bearing deposit portfolio, which at year end represented 39% of our deposit base. A 14 basis point improvement in our cost of funds driven by 19 basis point improvement in our cost of interest bearing liabilities. We also had higher securities yields and maintained strong loan 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-offs during the quarter, this brings our allowance for credit losses on loans to $81.1 million or 1.09% of loans from $84.5 million or 1.12% of loans at the end of the third quarter. Moving on to 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-insured expense for the quarter was $72 million, up from the $71.1 million in non-insured expense for the third quarter. Non-interest expense for the full year 2024 was $285.7 million, 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 16.06% at the end of the fourth quarter, relative to 14.02% at the end of 2023 and 12.39% 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 36.2% from $14.02 per share to $19.10 per share after dividends, representing a compound annual growth rate of 19.3% 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, notwithstanding 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 meaningful operating leverage as we create space from that $10 billion asset 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 from the line of Will Jones with KBW. Will, please go ahead.

Yeah. Hey, guys. Thanks. Good morning. Good morning, Will. I just wanted to start on expenses. I know that, you know, that full year they 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 the higher professional fees this quarter, whether there's know anything to kind of read into or anything kind of unique that that was uh you know happening in that line this year or this quarter now it's timing related to certain outside auditing uh outsource auditing uh engagements okay um 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 some 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 M&A is certainly out there because it would just help us get there a little quicker from an operating leverage standpoint.

Yeah, okay. That's helpful. Last one, Paul, let me just jump into the margin real quick. I know in the past, you know, we kind of talked about, you know, we're relatively neutral from a, you know, rate positioning standpoint. I guess just, would you just reaffirm that that's still how you guys are viewing it today? And, you know, as we look to 25, whether we see, you know, two cuts, three cuts, five cuts, could you 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 it relates to our margin. that we're really pleased with where it sits on an absolute basis and then as well when you adjust for purchase 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, looking forward to 2025. Thanks, guys. Thanks, Will.

And your next question comes from the line of Matt Olney with Defense. Matt, please go ahead.

Hey, yeah, thanks. Good morning. Just want to clarify the loan growth outlook for 2025. I think back in October, we talked around a mid-single-digit growth for 2025. 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 our goal is to get back to around that mid-single-digit, so that's the plan.

Matt, we're also, I think you mentioned momentum. Fourth quarter loan 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 24, 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-new, meaning the customers were not here before. And then we're watching those accounts as they grow, as they mature. And in dollar terms, our net new of was new exceeding closed was it 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 low to mid 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 that? the positive operating leverage comment.

Precisely. You somewhat answered your own question. It's about 3% in growth in non-interest expense, and the revenue dynamics we believe support that much or 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.

Thanks, Zach. 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 Skouten 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. You know, if I look at consensus numbers, it's, you know, maybe assuming... Earnings are down on a year-over-year basis, and some of that's provision-related. But I'm just wondering, I guess, are you guys thinking about operating leverage core execretion, or are you thinking about that on a cap basis? And if so, what do you think analyst expectations are kind of missing as it relates to that trend line?

We're seeking to deliver on both basis. And when... 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 do better, clearly, than what's out there in consensus numbers.

Got it. That's helpful. And then for that accretion, I think, you know, 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, you know, 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-industrial deposit growth, and you paid down borrowing. Do 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 in year-end balance sheet is going to be transitory relating to the seasonality of investments. 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 a 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, you know, let's call it around 150 a book and how that allows you guys to potentially pursue M&A or is that a hindrance at 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 detriment either. We'd like to see it 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 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 Rhodes with JT. John, please go ahead.

Good morning, guys. Paul, maybe... question for you on the securities portfolio, given 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 15 to 16 percent 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, I think, is what drives that level currently.

Okay. 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 CECL plays a big part, but can you just talk about how we should view the provision for 25?

This credit has been great in 2024, and as we look at 2025, it is covering the waterfall of growth in loans relative to charge-offs. 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 strong credit. And then there has been a measure of drivers in our reserve and partially a function of CECL that has been very asset specific loans that 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. 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 since 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 mid-teens is the right the right expectation to have and will 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. Okay. Thank you, guys. Have a nice day.

And your next question comes from the line of David Pfister with Raymond James, please. Let's go ahead, David. Hey, good morning, everybody.

Hey, David. I just wanted to start on 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. 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 certain aspects of it, office buildings to be one, which is something we don't play a lot in, but it has had its own damage. But for the most part, the resiliency of the economy here has allowed us to come through this 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 is still rolling on. I do worry a bit about inflation, but for the most part, I think there's clear sailing for us, and 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 of capital for.

David, we're waiting on year-end numbers, but we were trending towards population growth still in excess of 100,000. Job growth is 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, you know, just kind of maybe on the other side, right? With a really healthy economy. Also, that's where folks want to go, right? 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. You know, it's always competitive, right? It's a tough market. It's an 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, Texas doesn't go unnoticed by the world. We basically have every bank and financial institution in the world is right in our back door. 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 you know, our job is to kind of take some of that back, and I think that's kind of what we're focused on. We now are at a size that we can basically make loans across the spectrum, certainly not in competition with J.P. 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. 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.

David, we've got... Back to the momentum, we've got momentum there. I mean, over 50% of our new accounts, the number of new accounts, were to 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, 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, you know, opportunities to add new talent? Just kind of curious what you're seeing, because that's something that's always been a part of the bank is, you know, recruiting lenders. So just kind of 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 And we're seeing that out there. But our ODP program has been really fantastic and been able to provide us with some 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.