Stellar Bancorp, Inc.

Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Stellar Bank third quarter earnings call. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press the star key followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. At this time, I would like to turn the conference over to Courtney 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 third quarter of 2025. This morning's earnings call will be led by our CEO, Bob Franklin, and CFO, Paul Iggy. Also in attendance today are Steve Reitzloff, 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 Investigation Reform Act of 1995 as amended. We intend all such statements to be covered by the same type of provisions for forward-looking statements contained in the Act. Also note that if we give guidance about future results, that guidance is only reflection of management's belief at the time the statement is made and subject to change. We disclaim any obligation to publicly update any forward-looking statement except as may be required by law. Please see the last page of the text in this morning's earnings release, which is available on our website at ir.stellar.net for additional information about the risk factors associated with forward-looking statements. At the conclusion of our remarks, we'll 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 and welcome to the Stellar Bancorp third quarter earnings call. I'm pleased to report that we delivered solid results, including increasing our net interest income and our net interest margin. Our balance sheet expansion was driven primarily by deposit growth, reflecting our bankers' emphasis on getting the full client relationship. Credit quality has found its way back into the headlines. While we experienced some charge-offs in the quarter, they were spread over several small credits, most of which were already identified and appropriately reserved. We feel comfortable at our present level of reserve based on our portfolio and the markets that we serve. We have little exposure to non-originated credits and only have three shared national credits, all with longstanding and additional business ties to the bank. Overall, credit trends remain favorable and our market stable. Paul will provide more detail on our expenses during the quarter, including some one-time expenses and some increased advertising spend. As we continue to strengthen our capital position, we have repurchased shares and we have paid down $30 million of our subordinated debt just after quarter end. Our well-capitalized position gives us valuable flexibility and we remain committed to deploying capital in ways to enhance our shareholder value. We are focused on growing our company. We believe that if we continue to be disciplined in building quality assets, protecting margins, and focusing on full balance relationships, we will drive long-term value for our shareholders. Now I'll turn the call over to Paul Egge, our CFO, for more content.

Thanks, Bob, and good morning, everybody. We are pleased to report third quarter 2025 net income of $25.7 million, or 50 cents for diluted share, as compared to net income of $26.4 million, or 51 cents per share in the second quarter. These two represents an annualized ROAA of 0.97% and an annualized ROATCE of 11.45%. Key highlights of our third quarter performance were improvements in our net interest income and margin on incrementally larger interest earning assets. Our balance sheet growth was driven by strong deposit growth, and we feel great about our liquidity, capital, and overall balance sheet positioning. So during the third quarter, net interest income was $100.6 million, representing an increase from the $98.3 million booked in the second quarter, largely due to higher earning assets and net interest margin for the quarter. This translated into the net interest margin of 4.2% relative to 4.18% posted in the second quarter. Purchase accounting accretion in third quarter was $4.8 million, down from $5.3 million in the second quarter. So if you were to exclude purchase accounting accretion, tax equivalent net interest income increased by slightly more to $95.9 million from $93.1 million in the prior quarter, and that change in net interest margin excluding purchase accounting accretion was also greater, going from 3.95% in the prior quarter to 4% in the third quarter. We're really proud to get NAMM excluding purchase accounting accretion back to a 4% level, and we continue to feel good about our ability to defend and perhaps incrementally improve on our top-tier margin profile. by focusing on staying true to our core relationship banking model. Walking further down the income statement, we booked a provision for loan losses of $305,000 in the third quarter, which was driven primarily by an increase in our allowance for unfunded commitments and growth in that category. While we did experience $3.3 million in net charge-offs in the third quarter relating to over 10 relationships, Most of these were previously identified and already specifically reserved for, therefore not impacting our quarterly provisions. For a year-to-date perspective, our net charge-off totaled $3.7 million, or approximately seven basis points annualized. Our allowance for credit losses on loans ended the quarter at $78.9 million, or 1.1% of loans, which is down slightly from $83.2 million, or 1.14% of loans at the end of the second quarter. Moving on to non-interest income, we earned $5 million in the third quarter versus $5.8 million in the second quarter of 2025. This third quarter decrease was mostly due to approximately 445,000 of write-downs on foreclosed assets and lower other non-interest income during the quarter. On to non-interest expense, Expense increased to $73.1 million from $70 million in the second quarter, primarily due to an increase in salaries and benefits, and to a lesser extent, increases in professional fees and advertising. Salary and benefits expense included severance expenses recorded relating to two upcoming branch closures in the fourth quarter, which totaled about a half million dollars, as well as elevated medical insurance expenses relative to prior quarters. We view our third quarter expenses as an outlier, and we expect fourth quarter expenses to be closer to our run rate for the first half of the year. So all of this drove solid bottom line results of $25.7 million in net income, which continues to fuel our track record of internal capital generation in our very strong capital position. Total risk-based capital was 16.33% at the end of the third quarter, relative to 15.98% at the end of the second quarter. Year-over-year tangible book value per share increased 9.3% from $19.28 to $21.08 per share, and that is after the effect of dividends and meaningful share repurchases. I should note that our share repurchases in the third quarter was lighter than prior quarters, totaling just under $5 million, relative to a total of approximately $64 million in share repurchases year-to-date. In closing, we really like where we sit, both financially and strategically, even more so since recent M&A disruption in Texas accentuates our key differentiation as among the only truly focused franchises with scale in a competitive landscape comprised of increasingly larger out-of-state competitors. We've built a strong balance sheet that can support quality growth And with growth, we're positioned to deliver positive operating leverage through adding scale to the Stellar Bank platform while maintaining the financial flexibility to be opportunistic. Thank you, and I will now pass the call back over to Bob.

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

Thank you. We will now begin the question and answer session. If you have dialed in and would like to ask a question, please press star 1 on your telephone keypad to raise your hand and join the queue. We'll take our first question from David Feaster at Raymond James.

Hi. Good morning, everybody. Good morning. I just wanted to start on, let's start on the growth side. You know, I know somewhat of the decline is strategic and we've talked about that given your focus on a balanced approach, but I just wanted to get a sense on first off, you know, what's driving the payoffs and paydowns? You know, how much of that is competition versus just, you know, asset sales and those kinds of things. And then just how do you think about the growth outlook as we look forward? I mean, you know, Texas is a very competitive market on one hand, and, and, you know, that's maybe that could be a headwind, but at the same time you talk about the disruption and that creates a ton of opportunities, just given the strength of your franchise and your relationships, just wanted to kind of taking that all together. Like, how do you think about growth and just any insights you can provide on that?

Uh, Hey, sure, David. Um, yeah, so start maybe a little bit with what, what, what's, uh, what's impacting the growth, as when we talk about the payoffs, like you asked, the color around that. So, you know, payoffs this last quarter were about $50 million more than the previous quarter. So, you know, we talked about a run rate of around $300 million of payoffs. They were $330 in the last quarter. Year-to-date, about 44% of our payoffs are related to sale of collateral, sale of business. About 25% is kind of in that competitive area of refinance elsewhere. And those are the things that we take a look at around, you know, one, and as Bob already mentioned, us remaining disciplined around full relationships. So some of that, it will go away. But on that refinance elsewhere, if, you know, we put our best foot forward to try to keep some of that, but that's some of what we're what we're faced with. On the other component of that in the waterfall is, we've talked about it before, but what we call our carried, which is our advances versus our pay downs and scheduled payments. And as Paul mentioned, we had a reserve related to unfunded that continues to grow, but we're still not seeing the lift from that. So compared to the previous quarter, that was almost another 50 million of increase and payments and paydowns exceeding the advances. So that's an area where we think we will get a lift as we continue to originate loans. We're really pleased with the originations. The third quarter we originated almost 500 million of loans compared to 640 the previous quarter. But the real thing that I think we want to make sure we communicate is just overall year to date compared to last year, first three quarters, we're up 62% of loan originations and in the mix that we like with a little bit more CNI in that mix. So things are heading in the right direction. We just have to continue to convert on our pipeline, and pipeline remains healthy. I think a little bit of the originations that were down compared to the previous quarter were really due to, in some cases, it's competitive, obviously, but also just some things that are going to get pushed into the fourth quarter. But the pipeline remains healthy. And we're really pleased with where we stand there. That's great.

Maybe touching on the credit side a little bit, you know, concerns are, you know, they've gotten heightened in the industry right now. I guess first I was hoping you could maybe touch on what are you seeing on the credit front? Is there anything that you're seeing broadly that's causing you any concern? And then secondarily, I was just hoping you could maybe touch a bit on your approach to credit. you know, collateral management, stress testing, ongoing monitoring. It seems like some of those are what, you know, maybe investors are concerned about, you know, in the industry. So just was hoping you could elaborate maybe a little bit on your process and your approach to managing credit.

Yeah, I think the best way to manage credit is when they come in through the front door, David. I mean, so that's how we manage credit most of the time. However, we do stress testing. We do all the things that folks do to monitor portfolios. We're moving our portfolio from what was two smaller community banks into a larger community bank. It has a different look. I think you've seen it on our balance sheet as we've gone from where we used to run our banks at, say, 90 to 100% loan to deposits. We're now down about in the low 80s and feel comfortable there. We're able to make money there. We're changing the mix a bit to try to have a little more emphasis on stickier C&I credits. Now, we are very careful about how we approach C&I and how that's getting monitored and what we do to make sure that we have solid results around C&I. But we also continue to do real estate loans, and those things have been good to us over the years. We're in a market that continues to grow, and so real estate continues to be a good active place for us to put money. So I think we would be more concerned if we were in a less dynamic market, but we're in a very dynamic market. All the things that are affecting the world, for that matter, tariffs and the various things that are happening today, I think are being absorbed pretty well in Houston and Dallas and the markets that we're in, Vermont. So we feel supported by our markets, and I think it's about decision-making with them, and that's kind of how we approach it.

Okay. That's helpful. And then just wanted to maybe switch gears to the deposit side. I mean, your growth was really strong this quarter. You know, cost declined. Just wanted to get a sense of some of the drivers behind that. You know, how much of that is, you know, new clients versus, you know, increasing liquidity or relationships with existing clients. You know, and then just, you know, again, with the liquidity build, I mean, even after paying down borrowings, and buy a little bit of security. Just kind of curious what your plans are for some of that excess liquidity going forward.

Yeah, I'll touch up. Well, let me touch real quick on the deposits, on the deposit growth piece. So we're really pleased there, as we've already mentioned. So, you know, of our new deposits that were onboarded in the quarter, 51% were to new customers that had not been here before. And we've seen that kind of hover and that 40 to 50 percent all year, which we really like. And we think that's really a reflection of continued brand awareness of Stellar, our bankers that are really having good success with market share gains. You know, we've had improvement in our net promoter score, really getting into like a best in class area there. And customer satisfaction is all heading in the right direction. I think that just points to the fact that we continue to bring new customers to the bank as well as this expansion of our existing customer base, which represents that other 50%. But really, the growth is really around those new accounts and the deposits associated in that. They're well exceeding in dollar amount, the closed accounts, and our carry was nice and gave us a little lift.

Yeah, David, we just feel very strongly that low-cost deposits is something that everyone's going to be fighting over and something we put a big emphasis on in any relationship that we have. But we're going to continue to do that. I think we've seen some success as we did this quarter, and hopefully we'll continue to see that as we keep the push on that going forward. We are building some liquidity, and I think deploying that both in loans and securities is something that we intend to do in the future. But we want to grow the loan portfolio. That's where we grow customers. And that's how we continue to grow the bank. And it's important to us to continue on that lock. A lot of turmoil in our markets. A lot of M&A going on. So it's given us opportunity for customers. It's given us opportunity for new employees and people to join our company, which is great. I think it's... But it's also... add some negatives to it and that you have new players in that want to buy the market. And you're seeing some interesting things around not only pricing, but covenant packages and sort of credit light. And we're not going to join that party. That one doesn't fit us. And if we have to retreat a little bit, we'll do it. But we've been operating in a competitive market for a long time. We feel like we know how to do that. We'll get our share. and if we continue to do the right things, which I think we are, from a customer acquisition standpoint, we'll grow the bank. So that's kind of how we're approaching it.

That's helpful. Thanks, everybody. Thanks, Deb.

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

Hey, good morning everyone. Just following up on the deposits quickly, you've tended to have some seasonal strength in the fourth quarter. Is that something you would expect here this coming quarter as well?

We talk about that all the time because we do have seasonal strength with some of our government banking deposits. And in fact, last year we had about a $200 million deposit that came in in the last day. of 2024. It's kind of hard to predict as it relates to that. We'll keep you guys abreast if there's anything that majorly kind of creates a meaningful deviation from norm as we did, I think, last year in telling y'all just how much represents what we would call seasonal excess. So we'll note that when we report the third quarter, fourth quarter, I should say, if and when some of that tax revenue seasonality comes in before year end. A lot of it really hits in January and February, and it's kind of gone by March. But sometimes, and last year was a great example, where sometimes it comes in right before the end of the year.

But that's not reflected in this quarter's deposit, right? It doesn't happen until late in the fourth quarter when those government deposits.

Precisely. Perfect. Great. That's great, Keller. When you were talking a little bit about the expense ratio, saying it looked like this was maybe a bit of an outlier this quarter and could get back to that $70 million level, what makes this quarter more of an outlier? I know there was the severance payment in there, but what makes this an outlier? And do you think that kind of $70 million range is a level you can hang around in 26, or should we see just some kind of general inflation build from here?

I'll say, to be more specific, I said that we'll see fourth quarter earnings closer to our first quarter or first half run rate than what we posted in the third quarter. So it might not be just as great as the $70 million per quarter we were posting in the first half year, but definitely closer to that than the $73 million we posted in the third quarter. Separately, we will see Some inflation. I mean, as you guys know, we've been focused on holding the line where we can and really being focused on just that. We feel great about how we've been able to kind of stop the creep in expenses, particularly as it relates to a lot of what we had to build in crossing over the $10 billion threshold. We're in optimization mode on a go forward, and we've been really pleased at how we've been able to do just that while remixing kind of with attrition and things along those lines in our human capital base. So we feel really good about where we sit, and the goal is to continue optimizing and holding the line as much as we can going into 2026 and beyond.

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

Hey, great. Thanks. Good morning, guys. Hey, so Paul, maybe just sticking with you and moving to the margin discussion. I mean, if you exclude purchase accounting, we've kind of hit that 4% in those on that felt like kind of the overarching, you know, near term target for you guys. And I go back to your comments on the call about feeling good about the ability just to defend that level, if not even improve from here. But as we think about this next period of Fed easing, will that ability to defend, will that really be more of just some tailwinds from fixed pricing, or do you intend to be, you know, relatively aggressive lowering deposit costs from here?

You know, we're going to be focused on lowering deposit costs where we can. That predominantly is going to be on more of your specials and exception level pricing. That's where we've got some index pricing for certain deposit products that we're going get immediate benefit from when rates change. So we feel really good about the initial repricing dynamics. And then separately, there is some tail trends that are helping us in how our securities and loans reprice. So we're still in a pretty good backdrop to defend that margin. Debt gets reshuffled at every rate cut. There could be some timing distinctions, but we feel like we've got the benefits are likely to sufficiently mitigate the drawbacks of how those repricings go on. So we're feeling good about defending it. Actually, we're pleasantly surprised to have gotten the 4% NIM excluding purchase accounting accretion as fast as we did. We certainly did not promise that to the market and did not expect it necessarily to materialize as quick, but we're really pleased that we were able to do that, notwithstanding being a little less loaned up than what our budget and forecasts are and our plans to drive loan growth really are.

Yeah, I mean, well done there. And could you just remind us, is there a kind of a terminal interest-bearing deposit beta that you guys are trying to manage through this cycle? Maybe just as you look at what you were able to accomplish on the upgrade cycle?

We don't necessarily think of it in terminal basis. to gain as much ground as we can where we can. So just like on the upswing where we didn't, we weren't as aggressive in necessarily moving a lot of our kind of base sheet rates. And we were more focused on, okay, how do we manage this exception population and this index population? How do you really manage your most price sensitive customers on this positive side? And we're going to continue to do that on the way down. And it's a nuanced approach. We feel like we're approaching it with more discipline than we really ever have in having a game plan for every rate cut and being ready to manage all those conversations and really get the highest beta out of our largest absolute value exception customers. And that's all a reasonable ask. And it so far has functioned pretty well in the September rate cut. So we'll follow the same game plan as we go forward.

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

It's definitely an option, and it's something that we talk about every day, really. What is the right size of the bond book? How do we manage our balance sheet best? We feel awesome about the fact that we're building an even more fortress-like balance sheet with strong capital, strong liquidity, and a a really nice foundation to grow upon. So, we think that flexibility can allow us to be opportunistic when more meaningful loan growth presents itself or when other strategic opportunities can present themselves. So, we are very pleased to be having a very healthy and strong balance sheet.

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

as a reminder if you would like to ask a question please press star one we'll go next to matt olney at stevens uh thanks good morning um i wanted to circle back on the loan growth discussion and uh you know we talked about the elevated payoff a few minutes ago i'm just curious when do you expect this to flow i mean we're seeing rates move lower in the fourth quarter, an expectation that continues now for a little bit more. I would think that would just create more payoffs, not less, but just curious what your expectations are as when we could see this pressure ease up. Thanks.

Hey, Matt. So, one of the things that we will get a lift, we will get a lift from our advances exceeding our paydowns and payments, and that's When you go back and look at our history of when we were getting a lift, it patterns kind of this. It matches up with our loan origination. So as we said, loan originations are up 62%, but we will get some lift there, whether that's maybe a couple quarters away from that helping us and not taking away from loan growth. So that's kind of in the good news category. I think we're going to have to manage through the fact that we've got the way the portfolio, the nature of the portfolio of this $350 million of payoffs that we have, and we'll do our best to try to limit that through some of those loans that we're refinancing elsewhere to put our best foot forward. But the real story is going to be on that side. It's going to be the funded portion of the new loans that we originate. Our pipeline, again, our pipeline's healthy. If we're in this, you know, like last quarter, $600 million of origination, that's getting us closer to where that will get the fundings, even with the payoffs, to get us, as you know, last quarter we had a slight gain or slight increase in net funded loan balances. So it's a matter of delivering on that pipeline and continuing on the path that we've seen in the last couple quarters and really year to date. You know, we said before that we thought growth would manifest in the second half of the year. Of course, we still have the fourth quarter, but going into 26, we feel good that we will pivot to that.

Okay. Appreciate that, Ray. And also, want to get the updated thoughts around M&A. We're definitely seeing more M&A deal announcements in your backyard. Just curious about the conversations you're having with strategic partners and expectations for finding a partner for Cellar Bank. Thanks.

Yeah, Matt, we continue to have conversations. We talk to a lot of folks. You know, I think you've seen some transactions that we have some interest in and some not, I think the thing to remember and the thing that we want everyone to understand is that we're very protective of the balance sheet that we built and the deposit base that we built. And as we look at partners out there and how they've structured their funding, it would not behoove us to join somebody that takes away from the funding base that we have just to be larger. So I think what we want to do is make sure that we find the right partners to think about the world the same way we do and fund themselves in a similar fashion. So we continue to have conversations. I think there's a possibility we could be active in this space, but we're going to be careful about how we approach it.

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

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

Perfect. Okay, guys.

Thanks for your help. Thanks, Matt.

And that concludes our Q&A session. I will now turn the conference back over to Bob Franklin for closing remarks.

Thank you very much for joining our call today. With that, we are adjourned.

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