Stellar Bancorp, Inc. (NASDAQ:STEL) Q4 2023 Earnings Call Transcript

Stellar Bancorp, Inc. (NASDAQ:STEL) Q4 2023 Earnings Call Transcript January 26, 2024

Stellar Bancorp, Inc. misses on earnings expectations. Reported EPS is $0.55 EPS, expectations were $0.56. STEL isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. My name is Crista, and I’ll be your conference operator today. At this times, I would like to welcome everyone to the Stellar Bancorp Fourth Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to your speaker today, Courtney Theriot, Chief Accounting Officer. Courtney, you may begin your conference.

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 fourth 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 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 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 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.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.

Robert Franklin: Thank you, Courtney, and good morning, and welcome to the Stellar Bancorp fourth quarter earnings call. As we conclude 2023, I will begin by thanking the outstanding team at Stellar Bank. Their hard work and dedication allowed us to bring two banks together while dealing with the external pressures of current economic circumstances. Every day, we make strides in developing the Stellar way. Our team is working hard to ingrain our values across our organization, and our culture becomes more clear each day. We are pleased with our results for 2023, given all of the industry stresses while we focused on capital, liquidity and credit. Our discipline around these tenants allowed us to build capital to stabilize our valuable deposit franchise, maintain strong net interest margin while maintaining good credit metrics and finished the year with a nice return on shareholders’ equity for our shareholders.

Our mantra is 2024 — for 2024 is optimized. The heavy lifting is behind us. We must seek to optimize process, expense, people and future. We will keep our focus on capital, liquidity and credit as we expect a less robust economy in ’24 as the Federal Reserve continues to tame inflation. However, we operate in some of the best markets in the country, and we will be — we are well positioned to take advantage of the opportunities we expect to be presented to us over the year. We believe that these efforts and market dynamics will provide for a rewarding value creation for our shareholders. I will now turn the call over to Paul Egge, our CFO, for more details on the quarter and the year.

Paul Egge: Thanks, Bob, and good morning, everybody. After a year marked by industry disruption, we are very pleased to close out a strong and transformational 2023 for Stellar Bancorp. Our net income for the year was up $130.5 million, representing diluted earnings per share of $2.45, an ROAA of 1.21% and return on tangible common equity of 15.75%. As Bob noted, our focus entering into 2023 was on capital, liquidity and credit. And we feel we have performed well on all of these fronts, all while protecting earnings power, notwithstanding significant industry turbulence and competitive pressure during the year. On capital, in particular, we were very successful growing our regulatory capital ratios in 2023. We increased our total risk-based capital ratio to 14.02% at year-end from a starting point of 12.39% at year-end 2022 and showed similar improvement across all of our regulatory capital ratios.

Driving this capital build was our growth in tangible book value, which grew 21.4% over the year to $17.02 per share at the end of 2023 from $14.02 per share at the end of 2022. During the year, we also maintained a very strong funding profile marked by 40% non-interest-bearing deposits, along with a disciplined strategy with respect to our interest-bearing funding. As a result, we’ve been able to manage pretty well through a competitive high interest rate environment to maintain healthy margins and core earnings balance. All the while, we’ve been able to maintain a strong credit profile. Turning our focus to the fourth quarter. We earned $27.3 million or $0.51 per diluted share, making for an ROAA of 1.02% and a return on tangible common equity of 12.61%.

This was despite a higher expense flow during the quarter due primarily to nonrecurring items that I’ll detail shortly. Fourth quarter earnings were incrementally lower than the $30.9 million or $0.58 per diluted share earned in the third quarter due mostly to higher non-interest expenses more than offsetting higher non-interest income and lower provision. Notable among non-interest items during the quarter was a nearly $2.4 million in other non-interest income from FDIC investments. And on the expense side, we recognized a $2.4 million expense relating to the FDIC special assessment, $1.9 million of severance expense and elevated professional fees during the quarter, relating mostly to initiatives associated with crossing the $10 billion asset thresholds.

During the fourth quarter, we saw our net interest margin tick up a few basis points from the third quarter. Net interest margin was 4.40% during the fourth quarter, up from 4.37% in the third quarter. And excluding purchase accounting accretion, NIM was 3.91% in the fourth quarter relative to 3.87% in the prior quarter. We have been very pleased with the relative stability in our net interest margin during the back half of 2023, as the continued repricing of our assets has kept pace to offset an upward trend in funding growth, which has showed some signs of leveling off in the fourth quarter. We feel pretty good about stabilization in our margin trends and outlook, which continues to compare favorably relative to the industry, and we also feel good about our ability to protect our relatively strong profitability profile in this challenging environment.

With respect to purchase accounting items, we ended the year with $106.8 million in loan discount remaining and a core deposit intangible asset of $116.7 million. Strong earnings, notwithstanding accelerated amortization of CDI expense, has been a really strong driver to our internal capital generation in 2023, and we like our prospects for continued internal capital generation in 2024 as well. In summary, we believe Stellar is well positioned to perform in 2024. Our capital, funding and liquidity position puts us in a good spot to maintain favorable margins and earnings power. On credit, we feel appropriately reserved given current economic unknown, and we otherwise take comfort in our credit underwriting discipline and perhaps most importantly, the fact that we operate in some of the strongest markets in Texas and the country.

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

Robert Franklin: Thank you, Paul. And operator, we’ll be happy to take questions.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of David Feaster from Raymond James. Please go ahead. Your line is open.

David Feaster: Hi. Good morning, everybody.

Robert Franklin: Good morning, Dave.

David Feaster: Maybe just starting on the rate sensitivity side. You’ve obviously got a great core deposit franchise. We’ve seen core margin expansion throughout this rising rate cycle. But today, you actually screen closer to rate neutral, maybe modestly liability sensitive. Just given the increased prospects of rate cuts, I’m curious how you think about the impacts of potential cuts on the margin and how quickly you’d expect to be able to reprice deposits lower if we do get cuts this year.

Paul Egge: We take comfort in really a neutral interest rate risk profile. In our mantra — another mantra for 2024 is to be ready for anything. And that’s true on the interest rate sensitivity. We are very neutral. And to the extent we see rate down, there is a measure of sensitivity to the front end of the curve, particularly money markets and really short CD funding. So we see our ability to reprice there as — to be pretty strong. But once again, we’re not trying to make a bet on rates with our interest rate position, and we feel well positioned for really any rate outcome in 2024.

David Feaster: Okay. That’s helpful. And maybe just touching on the loan declines. Actually, maybe for another, how do you think about your ability to reprice deposits and the sensitivity of those clients? I mean, again, we were pretty slow to increase deposit rates. Do you think we’ll be able to — just kind of given the liquidity challenges in the market. I’m just curious how you think about repricing some of those deposits, including the competitive landscape.

Paul Egge: I think where you get the most ability to reprice is going to be in your exception universe as well as your — naturally, the wholesale funding that stayed pretty short, you can reprice.

Ramon Vitulli: Yeah, David. I would just add to that, the — Paul mentioned that are probably our largest opportunity is in that money market where on our sheet rates, we took a very measured approach. So that might be — we really weren’t very aggressive on the up. So on the down, it’d probably be similar. But we did as we handled the exception pricing, that would be where we would target first. The time deposits that we put on during this time were short term, and then of course, we enjoy a 40% plus NIB. So I think, as Paul mentioned, it will be in that money market bucket.

Robert Franklin: David, I’d just add, as you think about our approach to the deposit side, when the market changed and people were really aggressive about trying to fund our balance sheet, we felt like we didn’t want to get into that competition. It was above what we wanted to pay, and we wanted to retreat back to something that made sense for us and still maintain our great deposit franchise. Now as deposit rates start to level out, we can be as competitive as anyone on the deposit front. And we feel like we’ve got the ability to do what we need to do on a reprice basis to compete in the market. So we just want — we want rates to level out or give us some kind of idea that we’re not going to be paying outsized prices for these things.

David Feaster: Okay. That’s helpful. And maybe just touching on the loan side and the declines in the quarter. I’m just curious, how much of that is strategic and tightening and pushing higher pricing to kind of slow growth versus weaker market demand and just uncertainty in the economy from the client perspective? And just your appetite for growth today, where you’re seeing opportunities and kind of where pricing is holding up.

Ramon Vitulli: David, I think it’s a combination of both that you mentioned, both our underwriting approach as well as some demand pressure and that — as our customers are trying to get used to this rate environment. And so we’re seeing it on both fronts. We have a number of quarters in a row where our construction and development originations have declined, and that has been strategic, while our C&I has remained pretty constant. So as a percentage, C&Is increased a little bit. In the fourth quarter, we did drop a little bit compared to the third quarter in total originations, but feel real good about where those came on as rates. Still with an 8 handle on our new loans, and we renewed another $600 million kind of also with an eight handle. So we’re pretty pleased with that as well.

David Feaster: Okay. Terrific. That’s great. Last one for me. Maybe just touching on the expense side. Core expenses ticked up a bit. A lot of moving parts in the quarter. I’m just curious, how do you think about a good core expense level? And then just the run rate through this year, I mean how do you think about managing expenses just in light of some of the revenue challenges that we’ve talked about? Curious how you think about that.

Paul Egge: We guided 2024 expected expense on a core basis of around $280 million. There’s a lot of drivers that we’re going to be focused on optimization, as Bob said, to see the extent to which we may be able to do a little better. But ultimately, we feel like to achieve what we want to achieve into — pursue the initiatives we want to pursue in 2024 to position us best, that’s the spend level in the plan. Now the first quarter tends to be — had some seasonality to it that’s going to drive — going to be a little higher than if you were to divide that by four. But that’s where we’re targeting.