Stellar Bancorp, Inc.

Thank you for standing by. My name is Karen, and I will be your conference operator today. At this time, I would like to welcome everyone to this stellar quarter one, 2025 earnings conference call. All lines have been placed on mute to prevent any background noise. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star followed by the number one on your telephone keypad. To withdraw your question, you may press star followed by the number one again. I will now turn the call over to Courtney Theriault, Chief Accounting Officer. 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 first quarter of 2025. This morning's earnings call will be led by our CEO, Bob Franklin, and CFO, Paul Egge. Also in attendance today are Steve Rosloff, 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 our 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 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.stellerbankworkinc.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, Bob Franklin.

Thank you, Courtney. Good morning, everyone, and welcome to the Stellar Bank Corp first quarter earnings call. I begin by thanking our outstanding team at Stellar whose solid work continues to build a strong financial institution for our communities. As we entered 2025, we spoke of our focus on the customer, internal, existing, and prospective. Our focus is unchanged. We must acknowledge, however, that the administration has introduced a fair amount of uncertainty into the economy, though it is too early to see signs of impact on our communities. Our team will remain disciplined around credit as we monitor the impact of the new tariff policies on our customers and our communities. We continue to see opportunities for new customer acquisition, and our pipelines are growing, while we are also seeing significant commercial real estate pay downs as interest rates begin to stabilize. Given these conditions and the economic climate, we will proceed cautiously. Challenges also provide opportunity, and we took advantage of our strong capital position to return capital to our shareholders through meaningful share repurchases during the first quarter. The repurchases are in line with our goal to manage our capital to the benefit of our shareholders. We remain focused on building the great foundation our team has put in place. Given the economic uncertainty of the first quarter, we believe that growth will be pushed to the third and fourth quarters of the year. Although conditions make us cautious, our dynamic markets and our team keep us optimistic. I will now turn the call over to Paul Legge, our CFO, for more details on the quarter.

Thanks, Bob, and good morning, everybody. We are very pleased to report first quarter 2025 net income of $24.7 million, or 46 cents per diluted share, which represents an annualized return on average assets of 94 basis points and an annualized return on average tangible common equity of 11.48%. Key highlights of our first quarter performance included a reduction of non-interest expenses and a meaningful repurchase of common stock, along with the continuation of core net interest margin progress after seeing inflection during 2024. Our balance sheet shrunk during the quarter on a point-to-point basis, largely due to the seasonal outflow of government banking deposits and cash balances that had significantly inflated our balance sheet at year end, which we acknowledged during our last earnings call. Looking at it on an average basis, the linked quarter decrease in assets was much less significant and more reflective of the decrease in loans experienced during the quarter. The net result is a smaller but stronger and more core balance sheet with a very strong capital position. And that's notwithstanding our share repurchase activity during the quarter. And if not for two less days to earn interest in the first quarter, earnings would have been up relative to the prior quarter. Notwithstanding broader economic uncertainty, we believe we are well positioned to return to a reasonable level of growth during the year, albeit later than initially planned. And incremental growth will position us well to deliver operating leverage and earnings improvement in 2025. Net interest income for the quarter was $99.3 million, representing a decrease from the $103 million booked in the fourth quarter. This was largely due to lower purchasing accounting accretion and two less days to earn interest due to the 90-day quarter. This translated into a net interest margin of 4.2% in the first quarter relative to 4.25% in the fourth quarter of 2024. Purchase accounting accretion in the first quarter was $5.4 million relative to $7.6 million in the fourth quarter. Excluding purchase accounting accretion, tax equivalent net interest income decreased slightly in the quarter to $94 million from $95.5 million in the prior quarter, and net interest margin excluding purchase accounting accretion was 3.97% up from 3.94% in the prior quarter. Key drivers to the strong margin performance in the first quarter included the relative stability in maintaining a strong proportion of non-interest-bearing deposits, which represented over 37% of our deposit base, a 14 basis point improvement in our cost of funds, driven by a 21 basis point improvement in our cost of interest-bearing liabilities. Also, we had incrementally higher securities yields and pretty strong loan yields after excluding purchase accounting accretion. Walking further down the income statement, We booked a provision for loan losses from the first quarter of $3.6 million. In combination with minimal net charge-offs of $163,000 during the quarter, this brings our allowance for credit losses on loans to $83.7 million or 1.15% of loans from $81.1 million or 1.09% of loans at the end of the prior year. Moving on to non-interest income, We earned $5.5 million for the first quarter versus $5 million in the fourth quarter, noting that the first quarter benefited from small gains on sales of assets. Next, non-interest expense for the quarter was down $5.1 million to $70.2 million from $75.3 million in non-interest expense during the fourth quarter. This is better than planned and reflective of both some timing driven dynamics and our focus on holding the line on expenses where we can. Our strong bottom line results have driven a continuation of our track record of growing our regulatory capital ratios and book value per share since the merger. Total risk-based capital was 15.94% at the end of the first quarter relative to 16% at the end of 2024 and 14.02% at the end of 2023. our regulatory capital ratios at the bank actually ticked up. Year over year, tangible book value per share increased 14.3% from $17.23 to $19.69 per share, and that is after the effect of both dividends and the share repurchases. We continue to like our prospect for strong internal capital generation and the optionality that it creates, which we feel is very valuable in the current operating environment. During the first quarter, we acted on this optionality through share repurchases, buying about 1.4 million shares of our stock at a weighted average price of $27.99 per share. Additionally, we repurchased 679,000 shares at a weighted average price of $25.83 per share since the end of the first quarter, representing in total nearly 4% of our shares outstanding at year end. The Board of Directors also authorized a new share repurchase program, which allows us to repurchase up to $65 million in shares through May of 2026. While our preference would be to deploy capital through growth and M&A, we appreciate having the flexibility to pursue capital optimization through buybacks when appropriate. In closing, we really like where we sit, both financially and strategically. We've laid the foundation to support adding more scale to the Stellar Bank platform and it remains our goal to deliver positive operating leverage during the year while maintaining a really strong balance sheet and the financial flexibility to be opportunistic. Thank you, and I will now turn the call back over to Bob.

Thank you, Paul. I think, operator, we're ready for questions.

At this time, I would like to remind everyone in order to ask a question. Press star, then the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. The first question comes from David Pfister from Raymond James. Your line is open.

Good morning, everybody. I want to start on the loan side. You know, it sounds like we're cautiously optimistic about potential for accelerating growth that this might, you know, hopefully kind of the trough here. You just, I guess, first off, touch on the pulse of your clients. Obviously, there's a ton of uncertainty out there. So I'd be curious, what are you hearing from your clients and just how the pipeline's trending and how much of this decline is a function of payoffs and paydowns being elevated and higher than expected versus slower originations just given the uncertainty?

Let me set this up a little bit. I want Ray to come in and fill in. One of the things we've been focused on, David, is, I mean, I think when you see an MOE come together, especially the way ours did, is two real community, small community banks, and then combine into a bank that's over $10 billion in assets, there's some redistribution of how the loan book should look. And we've been attempting to kind of reconfigure what the loan side of our balance sheet looks like. In other words, be able to do across the board any type of loan that we want to do without being totally reliant on these sort of smaller real estate loans that we have all done in the past as a smaller community bank. So across the board, be able to do the things that we want to do. So there's been a real focus on it. and letting some of this stuff roll out. When we started this journey, we were over the regulatory guidance in both categories, both C and D and CRE. What we've done is focused on getting those balances back down to what looks more like a larger bank balance sheet. We've done that. We continue to see some of that roll off that we've really kind of focused on letting roll off. And then as we add to it, it's a little bit different focus on what we're adding to it. But I'm going to let Ray fill in the gaps here.

Thanks, Bob. David, to your question around pipeline and kind of the waterfall. So in the first quarter, our loan originations, and this kind of goes to the build of the pipeline and what we're seeing, If you compare it to the past four quarters, we've had two good quarters of solid originations that were in excess of the second quarter 24 and third quarter 24. So fourth quarter of 24 and first quarter, we're trending in the right direction, and it supports what we're seeing in the pipeline as far as deal flow, as well as just the absolute value of the pipeline, both in expansion of our existing customer base and new market share gain opportunities. If you look at where that's building, so long as we can convert, it'll continue to generate higher loan originations. And then we've got to see where those fund. But if they fund the way we think they're going to fund, that obviously gives us a lift to offset the payoffs, which have been about, call it $275 to $300 million a quarter. The other component of the waterfall that it really kind of goes to what Bob just talked about is that what we call our carried loans, which is our advances in less our payments on the whole book. And because of the posture that Bob mentioned, that has not given us a lift over the past four quarters. So as we continue to originate and get availability that we'll then fund, we should see a positive lift in the carried, which will help the overall loan growth story, which as we said, should be in the second half of the year. You know, we're seeing a little bit of growth in our unfunded commitments, which is good, which is kind of a leading indicator for that. So we feel good about it. You know, our team is laser focused. We know what's needed on the origination side in order to generate the growth. And to your question about customer sentiment, it's kind of the way we're talking about it. It's still early to tell. We have seen maybe some pull through of things like maybe some inventory purchases early. but we still think it's too early in that aspect. And as far as deal flow, what we're seeing in committee and what we're seeing in the pipelines, it's positive. Okay. Okay.

That's great, Collar. Maybe just touching on the deposit side, I mean, you used some pretty strong language in the press release, saying the market's intensely competitive. Could you just elaborate on that and touch on some of the trends you're seeing? Obviously, exclusive to the government deposits, just where are you having success

winning new relationships how do you think about quarter positive growth and opportunities to further you know optimize funding and maybe you know drive some you know further improvements in deposit costs even exclusively with bed cuts well we still we really like our new account um origination story so um you know first quarter onboarded uh and both number and dollar amount more than the fourth quarter um the nib mix is uh It's consistent with our overall bank NIP mix. And you can't talk about new accounts without closed accounts, and closed accounts were at the lowest level in four quarters. And of those new accounts, close to 40% were to customers that weren't here before, which we really love that trend. I think it talks about the stellar brand, where we sit in the market, our success in having doors open for us, And we continue, you know, as we're sixth in the MSA in deposit market share, kind of the opportunity to continue to take market share gains.

And that's notwithstanding our track record of not really being a market leader in price. We don't buy our deposit base. We work it the hard way, and it's reflective of the new account openings being skewed towards the way we want it, a lot of non-interest-bearing deposits and things along those lines.

Okay. That's great. And then just maybe shifting gears to credit quickly, not surprising to see some migration in non-accruals. It seems like it's across several segments, but maybe notably in CRE. Obviously, you've got a track record of being really conservative on credit, very disciplined. I was just hoping you could touch on what you're seeing on the credit side and maybe what you're watching more closely and especially anything that you're maybe more concerned with just given the trade wars, tariff issues, DOGE impacts, all of those issues.

Yes, Joe. The migration was in the owner-occupied CRE. I wouldn't classify it as anything related to tariffs or just some owner-occupied CRE with management issues, and we noticed that. and graded it appropriately and put appropriate reserves against it. What we're seeing, as Ray said, it's a little early in this tariff issue to know how it's going to affect it. There's a lot of talking, but we haven't really seen too much in the way of any deteriorating financial reports from the customers. So I think it's a wait-and-see attitude, but we're just taking... a cautious approach to it as we examine new credits and just wait and see what happens.

Has there been any adjustments to underwriting or risk ratings or management as a result of this?

No. I mean, we've always had a strong focus on primary sources of cash flow. We'll continue to do that as we write our credits and look at our credits. We want to know it. How we're going to get paid back and then what's the secondary source of repayment that will follow up on that. It's coming from credit enhancement, like guaranteed or additional collateral. But no, it's just a strong focus on operating cash flow. Okay. Perfect. Thanks, everybody.

Thanks, David.

The next question comes from Matt Olney from Stephen. Your line is open.

Hey, thanks. Good morning, guys. I want to dig more into capital. I think Paul mentioned the active buyback in the first quarter and even more activity in recent weeks. I think that makes a lot of sense considering the valuation and the capital. Just would love to hear just updated thoughts from capital from here, including consideration for additional

uh debt redemption um just with the context of course of just economic uncertainty yeah man i think you know we're we continue with the same posture that we've had on trying to decide what the what the right use of the capital is we continue to to build capital uh at a pretty significant rate um there's some stuff that that we are thinking about um possibly retiring, I think we weigh that versus the benefits of what buybacks might be or what refinancing that debt might look like and what the benefits of that are. But we're losing capital treatment on some of that sub debt. So we're going to make a decision around that a little later in the year. But we continue to build capital. which allows us some flexibility. It's certainly enough capital for what we think our growth is going to be over the next couple of years. And so we have the ability to use it for some other things at this point. We haven't given up on M&A. I think M&A is still out there for us, although I think it's been put on hold like a lot of folks. But I think people are still talking. We're still talking. We're still talking to folks. about transactions. I think it's a little bit different if you think about public to public versus public to private. Those conversations are a bit different. And most of ours tend to be with the private at this point. But so all of these things are still on the table. And I think we're going to have to balance that out over the rest of the year as to what the best place and utilization of that capital is. But that's kind of how we're approaching it.

Okay. Appreciate that. And I guess other capital options that your peers are considering at this point. I'm curious if this is on your radar as far as a focus, just whether it's, I think, security purchases, whether it's kind of a smaller wholesale trade with some wholesale funding, or or even a few years ago, I think you guys purchased some loans as well. Are those other options are being considered, or is the focus still on, like you said, that the buyback with kind of a longer-term eye on M&A?

Yeah. I mean, we're a core bank, and this is where we keep our focus. We don't manage this thing on a quarter by quarter basis. We've got a very good game plan around what we want this to look like in the markets that we're in. And we're on track to build this back the way that we think that it ought to be built in our market. So to do something on an ad hoc basis is probably not in our DNA. So we're going to continue on an organic basis to focus on the great markets that we're in. look for opportunities to add to partnership with someone else in the future, and then we can look at dividends or buybacks as those opportunities arise. I think we tend to like buybacks just because from a tax standpoint, it seems to be a little bit better way to return capital to shareholders, although, you know, dividends are nice also. So we'll continue to manage that as we go along.

Yeah. And for what it's worth, you've seen both. We've seen the increased dividends in the fourth quarter, and we've chosen to be selectively active on the share repurchase. So we appreciate that flexibility, and we think we sit in the catbird seat relating to having plenty of options and an ability to do a lot of things. But I'll end where Bob started. Our goal is to continue to be a core bank.

Yeah. Okay. Appreciate the commentary there. And then I guess switching gears, the other positive theme of the quarter that I saw was just a nice improvement on your interest-bearing deposit cost. We'd love to appreciate just how much more room you think you have to bring that down, whether the Fed kind of stays put or continues to cut rates and then for margin, takes a little bit higher. Love to appreciate your view of kind of the outlook there. Thanks.

Certainly. Well, the first quarter we saw what I'll call full quarter impact of a lot of the rate activity you saw in the back half of the year, including in the fourth quarter. And we work every day to try and optimize that mix, but we kind of see that we've gotten most of what we could out of that. Note our cost of deposits did not skew as high as a lot of our peers, so We're going to continue to work on working that down, but ultimately it's going to continue to be a slog. I don't think we're going to have or the world will see the same kind of improvement in the second quarter from the first quarter. But day by day, that's our job, continue to drive an optimal mix of deposits and try to grow that base. So we'll We'll be working just as hard, but the incremental return in terms of improvement is going to be hard to compete with this prior quarter's improvement.

Okay. And, Paul, I guess the last part of that question was just around the core margin, I think the 397XD accretion. We'd love to hear thoughts on kind of directionally where that could go.

uh pleased with showing incremental improvement uh three basis points quarter over quarter you know our goal uh would be to get uh a four handle back on our uh core net interest margin uh excluding purchase counting adjustments and you know we think we're on that path it's just uh uh given a lot of the uncertainty uh we we'd rather um uh under promise and outperform on that front I think every basis point from here is going to be a win, and we're just keeping our nose down to drive a core balance sheet, and with that, we believe, will come incremental improvement. But we're already in rare air, so every basis point we get from here is going to be considered a pretty good win, and we're going to continue to work on it.

Okay. Thanks for taking my questions. I'll step back.

again do they have a question kindly press star followed by the number one the next question comes from will jones from kbw your line is open yeah hey guys good morning thanks for the questions

So I wanted to circle back to the growth conversation. Ray, maybe if you could just help us frame what you kind of see and know is upcoming on the pay down front. I know it's been, obviously, a headwind for you guys, but more so a headwind for the broader industry. So just so we understand what the bar to chin is on the pay down front. And then just to the comments about growth being more back-end loaded, I know that you guys are used to kind of growing in that 5% to 8% range. What would you expect? We kind of immediately get back to that. that level, or is it really more of a slow grind as we move into the latter half of 2025?

Yeah, well, on payoffs, I mean, I think what we feel the kind of behavior of the portfolio is something like $275 to $300 million a quarter is kind of what we're experiencing in absolute dollar terms. On the growth side, you know, I think we talked about going into the years more like low to mid single digits and Obviously, we had the down in the first quarter, but again, as I said earlier, it's going to really come in two areas. One is just what's funded of new production, and then also where we start to see advances exceed payments. I think as we see that pipeline build and those originations start to increase, that should result in getting us over the payoffs and turn into growth. But again, as Bob mentioned in the beginning, we think that'll be in the second half of the year.

Yeah, great. Okay, that's a helpful color right there. I wanted to also circle back just on the margin. I appreciate the new slide, slide nine, the repricing slide. That's really great. It really helps kind of frame and visualize what the fixed repricing opportunity is. And it really seems like, you know, moving beyond 2025, that there's still a pretty meaningful, you know, repricing story out there. But just curious today on new loans, where you're seeing pricing come in, and what you're kind of seeing from a competitive standpoint on loan pricing?

Yeah, well, I mean, it is competitive for the good loans. So, but first quarter, our loan originations came on at a weighted average rate of 729. And our renewed loans came on at $748. Okay.

And are you still sticking kind of within the same, you know, fixed versus variable skew in terms of the broader portfolio? Is this really kind of more of a 50-50 mix?

Correct. On the new, yeah, on what's coming on new, yeah.

Okay, great. And then just lastly for me, I mean, Paul, the expense story this quarter was really, you know, quite positive. I know we kind of talked about being more in that 295 million range for this year. I know it's not as simple as just annualizing what you guys did this quarter. And it sounds like there may be a little bit of timing differences with some costs that are coming through. But could you just help us, you know, appreciate where you see expenses trending maybe into the next quarter and the balance of the year?

T. Certainly we work every day on expenses and we would caution against annualized in the first quarter, although. T. We have our notes the grindstone as it relates to to managing expenses, but also, we want to be as thoughtful as possible about continuing to invest in the business and what's going to drive growth and and go forward basis. T. So we look at this quarter as. T. Something that we can hold our heads high with respect to and. You know, we like our chances of beating that prior guidance, but we will continue to see incremental investment while always holding the line where we can. Some of, probably about 50% of the relative beat there was on timing related things that are likely going to come later in the month, particularly as it relates to professional services fees. and certain external audits and things along those lines that have to get done in a timely manner. So not all of it will get pushed into the next year, but we are as diligent as we've ever been, and we're very pleased with our performance on expenses here today.

Yeah, okay, great. Well, nice work there. Thanks for the questions, guys. Cool.

That concludes our Q&A session. I will now turn the call over to Bob Franklin for closing remarks.

Very good. Thank you very much for joining our first quarter call. And with that, have a great weekend.

Ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect.