Stellar Bancorp, Inc.

Thank you for standing by. My name is Rebecca and I will be your conference operator today. At this time, I would like to welcome everyone to the Stellar Bank Q2 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, Simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. Thank you. I will now turn the call over to Courtney Theriault. 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 second quarter of 2025. This morning's earnings call will be led by our CEO, Bob Franklin. and CFO, Paul Eckes. 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 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.steller.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.

Good morning, and welcome to the Stellar Bancorp second quarter earnings call. We are pleased to share our results for the quarter, evidencing the great work our team has performed toward our goals for growth. In the first quarter, we described how we thought the year would play out. with our loan volume stabilizing with payoffs in the second quarter, giving us momentum for growth in the third and fourth quarters. Our pipeline is healthy and continues to support growth. We are seeing great results from our business development efforts with new loan originations nearly doubling in the second quarter when compared to the first. This is the highest level since 2022, and we believe it marks the return to organic growth. In these efforts, we continue to be supported by the resilient Texas marketplace, which provides Stellar Bank with great opportunities. Our markets have seen M&A activity pick up, as many in the country focus on business-friendly states. With this consolidation comes some disruption, and we anticipate potential for both customer acquisition and talent as a result. Our foundation is our great balance sheet, exhibiting strong capital and liquidity and highlighting our commitment to core funding. These attributes provide us with a good net interest margin and plenty of optionality in the marketplace. A tribute to our disciplined approach around relationship banking. We continue to focus on expanding existing relationships and building new ones. Our strategy is clear, continue to build Stellar into the bank of choice in our markets for small business leaders. We are a community bank, and we understand that our commitment to relationship banking is what will drive long-term value for our shareholders. And with that, I'm going to turn the call over to Paul Legge for further color on the court.

Thanks, Bob, and good morning, everybody. We are pleased to report second quarter 2025 net income of $26.4 million, or 51 cents per diluted share. which is up from net income of $24.7 million or 46 cents per share in the first quarter. These Q2 results represent an annualized ROAA of 1.01% and an annualized ROATCE of 12.16%. Key highlights of our Q2 performance were non-interest expense management and low credit costs, primarily due to low net charge-offs. Our balance sheet grew incrementally, thanks largely to deposit growth, while loans ended the quarter slightly up from the first quarter. During the second quarter, net interest income was $98.3 million, representing a slight decrease from the $99.3 million booked in the first quarter of 2025. This was due largely to lower earning assets and slightly lower net interest margin for the quarter. This translated into still a healthy net interest margin of 4.18% in the second quarter relative to 4.2% in the first quarter. Purchase accounting accretion in the second quarter was $5.3 million, which was relatively flat compared to the $5.4 million in the first quarter. Excluding purchase accounting accretion, tax equivalent net interest income decreased slightly in the quarter to $93.1 million from $94 million in the prior quarter, and net interest margin excluding accretion was 3.95% down from 3.97% in the prior quarter. Margin performance during the second quarter was impacted by higher funding costs more than offsetting higher yields on earning assets, which resulted in that two basis point change versus the first quarter. We should note that that first quarter benefited from some deposit seasonality that impacted deposit funding costs to the positive in that quarter. second quarter margin, excluding purchase accounting accretion, and the cost of deposits we experienced still reflect an incremental improvement from the fourth quarter of 2024. So we continue to feel good about our ability to defend and incrementally improve our top-tier margin profile. Walking further down the income statement, we booked a provision for credit losses of $1.1 million in the second quarter, which was driven primarily by an increase in our allowance for unfunded commitments, DUE TO A NICE INCREASE IN OUR UNFUNDED LOAN COMMITMENTS DURING THE QUARTER. TO A LESSER EXTENT, THIS IS ALSO DRIVEN BY MINIMAL, THIS LEVEL OF PROVISION WAS DRIVEN BY MINIMAL NET CHARGE OFF. OUR ALLOWANCE FOR CREDIT LOSSES ON LOANS ENDED THE QUARTER AT $83.2 MILLION, OR 1.14% OF LOANS, WHICH IS DOWN ONE BASIS POINT FROM THE 1.15% OF LOANS THAT WE HAD AT THE END OF THE FIRST QUARTER. Moving on to non-interest income, we earned $5.8 million for the second quarter of 2025 versus $5.5 million in the first quarter. Here we must note the second quarter benefited from additional earnings from Federal Reserve Bank dividends as a result of Stellar becoming a member of the Fed at the beginning of the second quarter. Next, non-interest expense for the quarter was essentially flat at approximately $70 million This is better than planned and reflective of our focus on holding the line where we can on expenses. Our solid bottom line results have driven internal capital generation and our ability to maintain a very strong balance sheet and capital position. Total risk-based capital was 15.98% at the end of the second quarter relative to 15.97% at the end of the first quarter. Year-over-year tangible book value increased 10.8% from 18%. to $18 per share to $19.94 per share. And this is after the effect of dividends and some significant share repurchase activity over the last year. On the topic of share repurchases, we bought back 791,000 shares of our stock at a weighted average price of $26.08 per share during the quarter. In closing, we really like where we sit both financially and strategically. We are positioned to deliver positive operating leverage by adding more scale to the Stellar Bank platform and maintain a really strong balance sheet. We believe this will give us the financial flexibility to be opportunistic. Thank you, and I will now turn the call back over to Bob.

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

Again, I would like to remind everyone In order to ask a question, press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of David Fester with Raymond James.

Hey, good morning, everybody.

Hi, David.

I wanted to start first on the growth outlook. We saw loans stabilize this quarter, which is encouraging. I was just hoping you could maybe touch on the competitive landscape for loans, origination activity relative to payoffs and paydowns and what's driving the payoffs and paydowns. When do you think we can start seeing originations offset that headwind and growth start to accelerate?

Hey, David. Yeah, so the originations, as Bob mentioned, nearly doubled in the second quarter compared to the first. And our pipelines kind of support that level of continued originations. And when you look at the waterfall of what kind of where that needs to be, you know, we've got a pretty good feel around where payoffs are. And, you know, a lot of those are coming from just, you know, trades of properties as they sell. But kind of at that level, we originated $640 million in the second quarter, and that kind of resulted in this slight growth. So we know that's probably the bar where originations greater than that will result in some growth. The other component is what we call our carried, which is our advances less our payments. And because of the loans that we have been putting on, we should see a lift in future quarters in that area, where in previous quarters, that's actually been a a decrease for us because of where we sit with unfunded in our loans book. So kind of the two factors to your question about going forward is continue on the origination path and then see those loans that book have some advances that will exceed the payments to give us a lift there. We like where the rates came on for these loans. It's healthy as well. And even in, as you know, the markets we serve are extremely competitive, but we have Our bankers are out on the street. We've had some new hires that are starting to get some traction. We've had wins in the Dallas market and continue to get some market share gains here in the Houston-Beaumont region.

Okay. That's helpful. And maybe touching on the other side, the funding side, obviously there's been some noise there. I'm just curious, maybe the competitive landscape for funding in your markets and just the strategy and ability to continue to drive core deposits going forward and would you expect funding costs to kind of remain relatively stable or maybe increase? Just kind of curious your thoughts on the funding side.

You know, on time, we've seen a little bit of not so much on the competitive side on the time deposits. On the money market, there's absolutely competitive part there. And we've dealt with that through kind of what we call a measured approach with exception pricing where we need it. You know, we're... The second quarter in our net new, so in terms of dollar of open, less closed, was the highest in three quarters and the second highest in six quarters. And the mix of that 50% in the second quarter was to new customers that have not been at Stellar Bank before. So our approach and strategy is to expand our existing customer base, but then go out and kind of tackle what the market will give us. And we're well positioned for that.

Okay. And just last one for me, you guys have done a great job managing expenses. I'm curious, as you look at expenses going forward, is there more wood to chop on that front? Or just given the disruption around you, whether there could be some opportunities to maybe invest in new talent and maybe be a bit offensive here?

So I characterize our expense management as holding the line where we can. And that is so that we can be TAB, Mark McIntyre, opportunistic when the right opportunities come up as opposed to kind of feeling like we're on a deficit on spend and more spend would kind of put us in a less optimal place, so the net effect of our strategy of holding the line where we can. TAB, Mark McIntyre, opens up the possibility. TAB, Mark McIntyre, To be opportunistic but it's still a dynamic where we're going to focus on holding the line where we can so that. the revenue growth outpaces the expense dynamics.

Yeah, David, I think from that standpoint, we are certainly open for new talent. I think we don't stop looking for additional talent that would help us grow the bank. The nice part for us, I think, to some extent is that The back office build around the things that we had to do over going over $10 billion is pretty well done. So we don't expect growth in that area, but we certainly are looking for additional talent to help grow the bank in the future. So we won't let that keep us from acquiring talent.

Okay. That's helpful. Thanks, everybody.

Thank you.

Your next question comes from the line of Will Jones with KBW.

Yeah. Hey, guys. Good morning. Morning, Will. Hey, so, Paul, if I could just weave together some of the commentary on just maybe the deposit cost competition landscape and just mirror that with your desire to see some growth in the back half of the year, could you just you know, piece out what the implications are for how the margin could trend, you know, as we move into the third and fourth quarters of this year?

So we feel really good about our ability to defend our margin. There has been a little bit of mix shift in the kind of funding base, and that's been largely strategic. We've relied a little less on FHLB borrowings and brokered funds in the second quarter. Actually, I should say, relied a little less on FHLB borrowings and brokered CDs in the second quarter, and instead relied on a lower cost alternative to FHLB funding, which was an interest-bearing demand broker, which we've lowered our exposure to. But ultimately, that drove a little bit of a shift in cost in the kind of funding base during the second quarter relative to the first quarter. but really we feel awesome about where we stand currently in terms of at our low relative low points on usage of wholesale funds at the end of the second quarter. And funding composition is what's going to drive our ability to drive improvements to margin. If it stays more consistent as it currently stands, you know, we'll be able to go probably improve basis, improve margin kind of on a, basis point by basis point, night fight basis. If we're able to kind of continue to decrease our usage of wholesale funds, we may be able to drive a little better dynamic. So really focusing on staying core is what's going to help us drive what we think is a structurally strong core margin in our business. To the extent we backslide, we like our ability to still defend where we're at.

Yeah, that's great. I appreciate that thoughtful response. And I know you've talked in the past just about your desire to see securities balances grow a little bit. But as I look this quarter, they at least, you know, leveled out on an average basis here. Do you feel like you've done all you need to do in terms of building up that bond portfolio?

Yes, absolutely. I mean, we're still incrementally, we're satisfied with the size of it, and we'd incrementally grow pro to a degree, but we're focused on growing loans. We feel like we have a great liquid balance sheet. I'd say when you track the average balances in the second quarter versus the first quarter, the first quarter when we had benefited from the seasonality of our government banking business, we did incrementally invest in some securities in a ladder such that you had higher average balances in the first quarter. So that is a seasonal anomaly. But where we were in the second quarter is pretty much where we want to be. And I would say more on a percentage of assets basis. So if we're able to grow assets, we'll try to maintain around the same percentage of asset dynamic that we currently hold.

Yeah, okay. Great. Thanks, Paul. And then... You know, excess capital that you guys have, I mean, it's a high-class problem, and you're deploying that somewhat through buybacks, but valuations have also moved a little bit from where you bought back in the first and second quarter. Does that still play a role, you know, in your term, or do you really, you know, lean more into the organic growth as you see that opportunity picking up? Thanks.

You know, organic growth is the number one use of capital that we want to engage in. And secondarily, there's other strategic uses of capital for which we feel like we benefit from optimal flexibility upfront. And then, you know, last, share repurchases are an awesome tool for us. We were very active in the first half of the year. Our demand for share repurchases has really graduated based on price. So we're going to be, as you guys might have seen in the first half of the year, we're able and willing to be pretty aggressive when we feel like that dynamic is merited.

Understood. All right, guys. That's all from me. Thanks.

Thanks, Ms.

Will.

Ladies and gentlemen, if you would like to ask a question, Press star, followed by the number one on your telephone keypad. At this time, your next question comes from Matt Olney with Stevens.

Hey, thanks. Good morning, everybody. Good morning, Matt. I want to go back to the long growth discussion and dig in more to the originations that really improved this quarter that Bob noted. Any color on the mix? of originations. I know you guys have been working hard building out, um, kind of a CNI, more of a middle market strategy over the last year or so. Just any color on that progress and just the overall origination mix.

Yeah, Matt, the, um, no, it's, it's, as you, as you mentioned, the, um, we've had a good mix of CNI, um, in that, in there, you know, we got down to, um, really low levels on our concentrations on, um, TRE and CNB, so there's a little backfill in those areas as well, but we continue to push and look at opportunities on the CNI side, and we're pleased with where that's been, not only in the second quarter, but just over the past few quarters of our mix in the CNI front. So it's kind of all across the board. It looks similar to how we've originated. It's just at higher absolute dollar amounts.

Okay. Appreciate that. And then I want to go back on to the expense discussion. And, Paul, you mentioned the banks did a nice job kind of holding the line so far this year, and it looks like expenses are pretty flat year over year through the first half of the year. Based on where we're at today, you think it's reasonable to assume – James Rattling Leafs- Expenses just continue to remain flat for the remainder of the year and 25 as compared to 24 absent any of those investments that you'll be you know opportunistic looking for.

James Rattling Leafs- You know, absent opportunistic investment that's the goal is. James Rattling Leafs- hold the line right here we're really pleased with the fact that. James Rattling Leafs- we've been able to outperform our. where we initially budgeted and where we initially kind of positioned the expense story. And we're really pleased with us actually kind of meeting last year's guidance and beating this year's guidance. So that's the goal. But part and parcel to that is having that flexibility to be opportunistic.

Yep. Okay. Makes sense. And then on the discussion around the core margin, I think we've talked about kind of an intermediate term goal is getting back to that 4% margin. And we've talked on this call about the deposit cost competition, a little bit more of a headwind now than before. Is that 4% core margin, is that still a reasonable goal? And do you see any kind of potential Fed cut that we could see later on this year and the next year. Do you see that benefiting the margin as you stand today, or is that potentially more of a headwind if that were to happen?

It'll benefit the margin. I mean, when you get the right cut, we find that we have a little bit of kind of initial adjustment noise that's hard to parse out. But by and large, The normalization of the yield curve is going to benefit us and the industry. We really like where we sit, and we still have point-to-point inversions, especially where we kind of play in the yield curve. So with the front end coming down, if and when you have the rate cuts, that opens up more kind of structural opportunity for our margin to continue to improve in the medium term. Immediately there could be a little bit of noise, but we like where we sit, and it is our intention to scratch and claw back up to a four-handle on margin. Okay.

Appreciate the commentary, Paul. And then on the capital front, you mentioned the buyback on a previous question. What about, I think you also talked about Earlier this year, you paid down some debt. It seems like there's maybe another tranche or two of debt that could be redeemed. Just any update on the debt at this point?

We're looking at that kind of in conjunction. It's in the playbook with share repurchases and how we think about kind of the uses of our excess here. We are evaluating that really in line with the other options out there. So it's certainly there for us to consider.

Okay. And then I guess just on M&A, you know, we've seen a flurry of deals in your backyard over the last... few weeks, which is great to see. I'm just curious about the banks' M&A discussions and talking with potential partners. Just any update on maybe the pace of those conversations more recently?

Yeah, Matt, I think the pace of the conversations have been, you know, fairly kicked up a bit. And I think, you know, one of the things for us is just to make make sure we're mindful to stay disciplined around pricing. And, you know, I think some of this exuberance sometimes causes some disruption around pricing for some of these things. But I think, you know, we always make sure that we want to not do any damage to the franchise that we already have. But we are still seeking partners to help build a balance sheet, build a bank, and there's still some opportunities out there for us. And so we're going to continue those discussions.

Okay. Thanks for the update, guys.

Thanks.

Your next question comes from the line of John Radice with Janney.

Hey, good morning, guys. Good morning, John. Yeah. I guess most of my questions have been asked and answered, but Paul, maybe just one on the other income line item. You highlighted the Fed dividend. So all things equal going forward in the second half, does the other income line probably trend back more towards sort of the first quarter level?

Yeah, there is some lumpy pieces that fall into other income. One of them is our SBIC income, which sometimes can add some lumpiness to it. But the key and ongoing component to other income is going to be the new insurance of these dividends as a byproduct of holding Fed stock and being a Fed member. So that's going to go on in perpetuity. some of the other dynamics. I can't promise that there won't be volatility in that line, but net-net, what drove most of the difference between the first quarter and the second quarter is an ongoing benefit.

Okay. Okay. Sounds good. Thank you.

I will now turn the call back over to Bob for closing remarks.

Thank you, operator, and thank you to all of you that have joined the call this morning. And we are adjourned. Thank you.

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