Stellar Bancorp, Inc. (NASDAQ:STEL) Q3 2023 Earnings Call Transcript

Stellar Bancorp, Inc. (NASDAQ:STEL) Q3 2023 Earnings Call Transcript October 27, 2023

Stellar Bancorp, Inc. beats earnings expectations. Reported EPS is $0.58, expectations were $0.56.

Operator: Good day, and thank you for standing by. Welcome to the Stellar Bancorp Inc. Reports Third Quarter 2023 Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Courtney Theriot, Chief Accounting Officer.

Courtney Theriot: 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 2023. This morning’s earnings call will be led by our CEO, Bob Franklin; and CFO, Paul Egge. Also in attendance today are Steve Retzloff, 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 the 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 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 statements except as maybe 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.stellarbancorpinc.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.

Bob Franklin: Thank you, Courtney, and good morning, and welcome to the Stellar Bank — Bancorp third quarter earnings call. I will begin my comments by thanking our fine team at Stellar Bank for their great work and extra effort to strengthen Stellar Bank’s infrastructure. Our combination just over a year ago is now in its second phase of refinement following our core conversion, developing one culture, developing and better defining our staffing needs, refining our expenses to scale to an $11 billion organization, and aligning our efforts to make Stellar Bank the bank of choice in our markets. Though the industry continues to experience pressure on the deposit side, due mainly to interest rates, we have seen our base move towards stabilization.

Rates have also put pressure on our net interest margin, but the negative effects are beginning to minimize, and though, we would not call a bottom, with the uncertainties that still exist in the market, we feel we are close. Our credit metrics remained good and our markets remain strong, but we must be cautious as the effects of rapidly rising interest rates work through the economy. We did charge-off one loan in the quarter, which was the result of a continued deterioration of a previously identified credit noted in the fourth quarter of 2022. The issues experienced in this credit are specific to the borrower and do not appear to be a trend within our loan book. We continue to believe that our underwriting and our markets remain good. We are determined to concentrate on building capital, liquidity and staying focused on good underwriting.

We are also making sure that we monitor our existing portfolio for any negative trends that may form in the future. We are pleased with our balance sheet positioning as we move to the fourth quarter of the year. Our goal is to put our institution in a position of having all options available to it as we move into 2024. Achieving our goal will create value for our shareholders, our employees, our customers and our communities. I’ll now turn the call over to Paul Egge, our CFO.

Paul Egge: Thanks, Bob, and good morning, everybody. We are very pleased to report strong operating performance in the third quarter. Our net income was $30.9 million, representing diluted earnings per share of $0.58, an annualized ROA of 1.14%, and return on tangible common equity of 14.5%. This was incrementally lower than the $35.2 million, or diluted EPS of $0.66 per share earned in the second quarter due mostly to increases in funding costs more than offsetting increases in interest income, higher noninterest expense and lower noninterest income. Notable among the noninterest items with our control of core noninterest expense after excluding merger expenses and for noninterest income, the decreased revenue effect from the Durbin Amendment on our debit card and ATM card line item and reduction in NSF fees.

During the third quarter, core net interest margin, which excludes purchase accounting adjustments, contracted by 10 basis points versus the second quarter and was 3.87% in the third quarter. That said, we are pleased to have experienced relative stability in our core net interest margin since May on a monthly basis. Since May, after experiencing meaningful funding dislocation in March and April, our funding costs have continued to trend upward, but at a more measured pace and the repricing of our assets had been able to keep pace enough to maintain stable monthly core net interest margins as we entered and exited the third quarter. While we do not like to see a decrease in our NIM or pre-tax provision profitability, we feel pretty good about the stabilization in our margin trends and earnings power, which continues to compare favorably relative to the industry and we also feel good about our ability to protect our relative profitability profile in this challenging environment.

With respect to purchase accounting items, we had $119 million in loan discount remaining and a core deposit intangible of $122.9 million at the end of the quarter. Strong earnings notwithstanding accelerated amortization of CDI expense has really helped us to internally generated capital at a nice pace, reflected and having shown well over 100 basis point increases in all of our regulatory capital ratios over the last third quarters. In summary, we believe Stellar is well positioned to manage through the current operating environment and thrive. Our funding composition and liquidity position, puts us in a great spot to maintain favorable margins and earnings power. Finally, on credit, we feel appropriately reserved given the current economic unknowns and we otherwise take comfort in our credit underwriting discipline from lending in one of the — and from lending in one of the strongest markets in the country.

Thank you. And I will now turn the call back over to Bob.

Bob Franklin: Thank you, Paul. And we’re ready for questions, operator.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from Eric Spector with Raymond James. You may proceed.

Eric Spector: Hey, good morning everybody. This is Eric dialing in for David Feaster. Congrats on a good quarter. Just wanted to touch on maybe some of the trends on the core funding side. Obviously, you’ve seen some migration, but just curious, some of the underlying trends you’re seeing maybe how new core deposit pricing is trending for core products as well as CDs, and just kind of how you think about deposit balances going forward?

Ray Vitulli: I’ll do it. Hey, Eric, this is Ray. So, on those deposit trends, we felt good about third quarter when we look at the dollar amount of new — that exceeded closed, that really held nicely. It’s actually held nicely over third quarters in a row. And then, if you look at our, what we call the carried, which is what’s existing prior to the new enclosed, that — those outflows, there still were some outflows, but they really decelerated at a nice pace to where we almost got to core, but there is still a core outflow to the net for the total but it’s significantly decreased from the previous two quarters.

Bob Franklin: While there were some shrinkage, we kept the composition relatively similar. So, when you think about our funding base, we still — we succeeded in having stability in our noninterest-bearing deposits ratio, and everything else, including our wholesale funding dependency, really mirrored where we were at the second quarter.

Eric Spector: Got it. I appreciate the color. Just kind of following up on that, just curious how you think about the balance sheet, and just the margin trajectory assuming a higher for longer environment? Just kind of any color on the bank’s performance or broader economic issues that you think could arise in a higher for longer environment? Just kind of how new loan yields are trending, color on like loan repricing dynamics, and how the loan yields are versus roll-off rates? Any color on that end would be great.

Bob Franklin: Certainly. I mean, the best takeaway we have that we feel good about coming out of September and really the last five months is a relative measure of stability in our net interest margin. So notwithstanding the fact that the cost of funding continued to trend upwards. It’s very much been an equilibrium in lockstep with the rate of change in our asset on the asset side. So, we feel good about the stability there. We think the more time we’re higher for longer, it will give more time for our asset book to reprice. Over the longer term, we see net benefit there, but we’re very, very cautious around how we manage the uncertainties of this unprecedented interest rate environment. So right now, we feel pretty pleased, but we’re just cautious about outlook and feel good about where we sit.

Ray Vitulli: Hey, Eric, I can give you some numbers, some color on the new loans. So, new loans for the quarter originated $340 million, that was at 8.12%, we picked up 50 basis points from the prior quarter on that. And then, we renewed over $600 million of loans in the quarter at 8.71%, and that was a picked up of 65 basis points from the previous quarter.

Eric Spector: Got it. That’s really helpful color. And then, just wanted to touch on the securities book. You have advantage of having a truly liquid portfolio. I guess if we continue to see deposit, how do you think about security sales versus borrowings versus CDs and other types of non-core funding? Where are you comfortable with that loan to deposit ratio shaking out? Maybe if you could just remind us what cash flows from your securities portfolio are that will be helpful.