Stellar Bancorp, Inc. (NYSE:STEL) Q2 2024 Results Earnings Conference Call July 26, 2024 9:00 AM ET
Company Participants
Courtney Theriot - Executive Vice President, Chief Accounting Officer and Controller, Stellar Bank
Robert Franklin, Jr. - Chief Executive Officer
Paul Egge - Chief Financial Officer
Ramon Vitulli - President, Stellar Bancorp, Inc., and Chief Executive Officer of Stellar Bank
Conference Call Participants
David Feaster, Jr. - Raymond James & Associates, Inc.
Will Jones - Keefe, Bruyette & Woods, Inc.
Matthew Olney - Stephens, Inc.
John Rodis - Janney Montgomery Scott, LLC
Operator
Thank you for standing by. At this time, I'd like to welcome everyone to the Stellar Bancorp, Inc. Q2 2024 Earnings Call. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you.
I'd now like to turn the call over to Courtney Theriot, Chief Accounting Officer. Please go ahead.
Courtney Theriot
Thank you, operator, and thank you all that have joined our call today. Good morning. Our team would like to welcome you to our earnings call for the second quarter of 2024. 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'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 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.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.
Robert Franklin, Jr.
Thank you, Courtney. And good morning and welcome to the Stellar Bancorp earnings call for the second quarter. We are pleased to report our results that represent the great work of the Stellar team.
Our goal has been to de-risk our balance sheet during the cycle of higher interest rates by focusing on capital, liquidity, and credit. Our second quarter results reflect these efforts. Our commercial real estate portfolio is now within the regulatory guidance and our goal is to manage and maintain these levels moving forward.
While our focus has always been and will remain on relationship banking, we are taking a more balanced approach to our lending. This approach includes a higher emphasis on small to medium-sized businesses and we continue to emphasize the acquisition of those operating accounts that are so important to our organization.
We have added great personnel to our staff to lead these efforts across our footprint, and we are pleased with the success of our officer development program and how they have supplemented our C&I efforts. We look forward to great results from them over the years to come.
We remain cautious as we look to the back half of the year without clarity on interest rates, as well as being in an election year. We are excited about the future and ready to play offense when the economy and quality funding create room for growth.
Our goal has been to provide Stellar Bank optionality and strategic goals by building a strong deposit base, maintaining a good net interest margin and building our capital base. We believe this positions us to take advantage of opportunities as they present themselves moving into and through 2025. We are well positioned and proud of the markets we serve in building our strong Texas franchise.
I will now turn the call over to Paul Egge, our CFO, for more detail on the quarter.
Paul Egge
Thanks, Bob. And good morning, everybody. We are pleased to report second quarter net income of $29.8 million or $0.56 per diluted share, which represents an annualized ROAA of 1.13% and an annualized ROATCE of 12.82% as compared to first quarter earnings of $26.1 million or $0.49 per diluted share, which made for an ROAA of 0.98% and a return on average tangible common equity of 11.47%.
We are proud of our results, particularly since we've been able to maintain a solid performance profile while we optimize our balance sheet risk profile through maintaining that focus on capital, liquidity and credit as we navigate 2024.
The net result has been a lower emphasis on loan growth as we seek to diversify our lending business, build a more liquid balance sheet and accrue capital.
On the earnings front, we feel great about our ability to protect earnings power, notwithstanding the pressures from the current interest rate environment and managing the responsibilities that come from being just over $10 billion in assets.
So, net interest income for the quarter was $101.4 million, representing a decrease of about $700,000 from the $102.1 million booked in the first quarter of 2024. This translated into a net interest margin of 4.24% in the second quarter relative to 4.26% in the first quarter 2024.
Purchase accounting accretion was $10.1 million relative to $8.6 million in the prior quarter. Excluding purchase accounting accretion, net interest margin was 3.82%, down from 3.91% in the linked quarter and reflected the full quarter margin impact of the funding mix shift that we experienced in the first quarter. Notwithstanding the mix driven uptick in our cost of deposits, we are very proud of how favorably our cost of deposits at 2.16% compared to the broader industry.
The primary driver of our cost of funds advantage is our high level of non-interest bearing deposits and we feel really good about how our level of non-interest-bearing deposits has stabilized after seeing outflows in the aftermath of SVB in 2023 and the cumulative effects of the rate cycle.
As a result of this stabilization and seeing the cost of our interest-bearing liabilities start to plateau, we see the second quarter net interest income levels as a relative trough from which to grow from in the back half of 2024.
Walking further down the income statement, we booked a $1.9 million reversal of provision for credit losses in the second quarter versus a $4.1 million provision for credit losses in the prior quarter, mostly due to stable credit and lower loan balances.
Since annualized net charge-offs were negligible and loan balances decreased, our allowance for credit losses actually ticked up to 1.23% of total loan balances from 1.22% in the prior quarter, notwithstanding that reversal.
Moving on to non-interest income, we earned $5.4 million for the quarter versus $6.3 million in the first quarter. I should note that the prior quarter benefited from nearly $0.5 million gain on the sale of assets and some SBIC income in the quarter.
Last, non-interest expense for the quarter was $71.2 million, down slightly from the $71.4 million in non-interest expense from the first quarter. Excluding notable non-recurring items such as additional FDIC special assessment charge that totaled $420,000 and approximately $450,000 of severance and certain other items, our non-interest expense was generally in line with our expectations for the quarter.
Given cumulative industry pressures and our position at just over $10 billion in assets, we feel great about our earnings power relative to the industry, our positioning for future organic and inorganic growth opportunities, and the potential for meaningful operating leverage when we add more assets to the Stellar Bank platform that we've built.
As it relates to capital, we've been very successful growing our regulatory capital ratio since the merger and the second quarter was no exception. Total risk-based capital was 15.34% at the end of Q2 relative to 14.02% at the end of 2023 and 12.39% at the end of 2022. This progress has been consistent across all regulatory capital ratios, and is reflective of our tangible book value growth since closing the merger, which is also thanks to a relatively strong earnings profile, notwithstanding a very accelerated amortization of CDI expense. We continue to like our prospects for internal capital generation, which we feel is very strategically valuable in the current operating environment.
We ended the quarter with $104.3 million in core deposit and tangible assets and a remaining loan discount of $87.4 million.
In summary, we believe that Stellar's consistent focus on capital, liquidity, and credit has served us very well as we navigate today's uncertain economy. The incredible strength and resilience of our market is advantageous from a credit standpoint and will prove just as advantageous when the time is right to be more assertive about loan growth.
We believe our strategic positioning as the largest locally focused bank in the markets we serve will continue to drive our success in the remainder of 2024 and beyond.
Thank you. And I will now turn the call back over to Bob.
Robert Franklin, Jr.
Thank you, Paul. And, operator, I think we're ready to take questions.
Question-and-Answer Session
Operator
[Operator Instructions]. Our first question comes from the line of David Feaster from Raymond James.
David Feaster, Jr.
Maybe just starting with the decline in loans. I'm curious if you could help us think through what's going on. How much of this is strategic, just given less appetite for CRE at this point, and maybe tightening structures and standards ahead of a potential credit cycle versus weaker demand or increased payoff activity. Just kind of curious if you could help us think through what drove that and your appetite for credit today.
Robert Franklin, Jr.
David, I think you may have answered your own question there pretty much. Given the environment, we wanted to make sure – and when we put the two banks together, we had a significant amount of CRE on our books and we wanted to get that down – for a number of reasons down under the guidance. So we've accomplished that at this point and are starting our sort of a more balanced effort as we start to grow the portfolio back.
And we've been cautious. We have been cautious this year around what the damage to the economy is going to be around interest rates. And I'm not sure we've totally experienced that yet in the markets. Our market continues to be good.
Loan demand, I would say, is still okay. But it's certainly not robust as it had been, say, earlier in the year or even last year. So I'm going to let Ray make some comments on this because he's got some good information, I think.
Ramon Vitulli
David, in addition to what Bob said, as far as like the waterfall of how we got there in the quarter, we've been originating around $300 million for the last four quarters. But the second quarter was down about around $250 million. So, that was about $50 million less than what we've historically been originating in this posture that we've taken. And then, our payoffs did increase. So we've been somewhere around $250 million a quarter in payoffs and the first quarter was $320 million. So, those are elevated payoffs. And then, the other component, which we call our carried, which is our advances net of our Payments because of where we've – the posture we've taken around C&D and that availability and that bucket going down, that carried actually flipped to the negative. So we actually had about a $30 million payments exceeding advances, which is probably what we'll see until we until we take a more offensive approach.
David Feaster, Jr.
It kind of sounds like loans treading water here stabilizing.
Robert Franklin, Jr.
Stabilize, I think – we're making this transition to a little more balanced approach and a little more emphasis on C&I. We've also brought down the C&D part of that. So as these construction loans funded out, we haven't been replacing them in this robust a fashion as we had couple of years ago. So it's really a more balanced approach on how we grow the organization and I think we get through sort of all the noise in the marketplace from interest rates to presidential election to what all the other things that are going on out there that we are well positioned to move forward. And I think as we get more comfort in that, that's exactly what we'll be doing.
And our markets continue to grow and continue to see job growth, population growth here and I just think the future is really good for this franchise.
David Feaster, Jr.
Well, maybe staying on that kind of side, you've historically had a lot of success recruiting talent. I'm curious, maybe what you're seeing on the hiring front. Do you have any appetite for new producers here and where would you be interested in deepening your presence or potentially interested in market expansion at all. Just kind of curious what you think on the hiring front.
Robert Franklin, Jr.
Hiring front has been really good. We've been able to attract some great senior C&I talent that is just getting their feet wet and getting going. We're producing our own through our ODP program, officer development program and pushing those folks towards the C&I side of the business and I think that's going to pay off as we as we move down the road.
But Stellar Bank is becoming a place that people feel very good about coming to work for and we've seen the talent migrate in our direction. We've had some great opportunities to bring some people on and we're going to continue to do that. We're continuing to look for talent all across the board.
David Feaster, Jr.
Last for me, great stabilization in NIB balances, especially with some of the delevering of C&I borrowers that we've seen and seasonal issues. I'm curious if you could help us think through some of the underlying trends that you're seeing and whether you think this is just kind of a sustainable stabilization and funding costs should start to stabilize and could ultimately translate into margin expansion and NII growth going forward. Is that the right way to think about it?
Robert Franklin, Jr.
I think we look at the leading indicator on our new accounts onboarded and it's had another strong quarter. In fact, dollar amount was one of the highest quarters of new onboarded accounts that we've had in four quarters. So really pleased there.
And the other component of that, which we're really excited about, is that 55% of those onboarded number of accounts were new customers. So I think that reflects on our bankers out in the field and as well as our brand. And inside of that, of the non-interest-bearing new accounts, 69% of the non-interest-bearing were customers that not that have not been here before. So, we think those are great trends and I think that will – as we move forward and those accounts build because they start typically at a lower balance, obviously, that that will result in what you're talking about of how we how we maintain this level of mid and also maintain or deal with our cost of funds.
Ramon Vitulli
David, we've been trying to wait to a point where some of the noise in interest rates, especially on the deposit side, get drowned out a bit. And I think we're starting to see stabilization across the industry. We're not seeing reaches for higher and higher interest rates.
The thing that we know about our franchise is that, once we get a level playing field, we can compete for deposits and loans for that matter, but certainly for deposits, and that's been our background. And so, we think that's starting to inflect and get to the point where things will be a lot more competitive and where we're competing on quality rather than just higher interest rates.
Operator
Our next question comes from the line of Will Jones at KBW.
Will Jones
Paul, I just wanted to start on the margin and maybe more specifically deposit costs. It was a bit surprising maybe to see a little bit of an acceleration this quarter in deposit costs after just comparing it to what we saw in the first quarter. And I kind of go back to your comments last quarter about the necessity to see a little bit of liquidity build. I guess question is, is that kind of a little bit of the driver of this quarter's change? And then it's been a broader narrative this quarter that, yes, maybe deposit costs continue to see pressure in the early half of the quarter, but moderated and maybe even stabilized as we entered the latter half. Would you guys kind of describe that as the trend for your deposit costs this quarter?
Ramon Vitulli
No, I'll start with the drivers of margin. And I would say really the big driver was the cost of funds. And ultimately, what you saw in the second quarter was really the full quarter effect of how our mix of deposits shifted during the first quarter of 2024. So, probably around mid-quarter, mid to late quarters where you saw – where we experienced a measure of non-interest bearing outflows and that kind of resetting the deck and effectively replacing non-interest-bearing balance with interest-bearing-balance is ultimately what drove kind of a higher entrance cost of funds in the second quarter.
The really good news is the extent to which it's been rather stable. So we have experienced up to this point, and if we were to review kind of on a month-to-month basis, a pretty high level of stability in cost of funds. In fact, probably one of the worst cost of funds months was likely April, but it has been relatively stable and it has been improved materially, but we're pleased to be experiencing relative stability and have experienced monthly stability throughout the second quarter.
Will Jones
If we just kind of pair that commentary, maybe we see deposit cost stabilize here – and with the expectation that NII troughs this quarter and expands from here on out, would you expect margin stability going forward or is there opportunity to maybe see a bit of expansion as we exit the year?
Ramon Vitulli
I think stability to expansion, I'd actually rather speak in net interest income terms. It's kind of where we're more confident in the trough by virtue of some – as we build some on balance sheet liquidity and pivot to a larger securities portfolio and whatnot, that can have less of an effect on non-interest income as it might have diluting the net interest margin metric. Ideally, we get both, but I see net interest income inflecting perhaps a hair before the metric of net interest margin inflects because of some of the inherently dilutive effects of building liquidity on our balance sheet to that statistic.
Will Jones
Bob, just a bigger, broader question for you. We've talked quite a bit about your hiring opportunities and what you're doing internally and reinvesting just from an organic standpoint, but what is the conversation like from an inorganic perspective? What is the M&A discussion that's happening in the markets today? Are you seeing any pickup in conversation or any incremental interest in the M&A space?
Robert Franklin, Jr.
Yeah, I think there continues to be a lot of conversations across the industry and we're having a significant amount of conversations ourselves. One of the things that we always worry about is how does a future acquisition target look in the way they fund themselves. And the biggest focus for us is trying to maintain the funding profile that we have, which is difficult, and it's hard to find good partners that kind of look the same way. And so, we feel very strongly that the value created for shareholders is around the deposit side, especially as we move forward. I think it's becoming more and more important every day. And so, the field gets narrowed a bit on who our acquisition targets might be, but we're having a lot of conversations. There's several folks that I think are starting to understand that the difficulties going forward and the valuations may not be exactly what their expectations were going to be, but maybe that the right choice is to find the right partner. And we intend to be the partner that they choose when they come around to decide and they want to make that exit.
Will Jones
I certainly understand wanting to maintain that attractive funding profile.
Operator
[Operator Instructions]. And our next question comes from the line of Matthew Olney from Stephens.
Matthew Olney
Paul, I want to go back to something you mentioned earlier. You mentioned building a larger securities portfolio and we saw some of this in 1Q, again in 2Q. I think these end-of-period balances are close to $1.6 billion. We'd love to hear an update on what you've been buying more recently and then expectations for continued build of that portfolio in the back half of the year.
Paul Egge
Certainly. We've been keeping it very vanilla, low risk-weighted agency securities and really changing to a focus of cash flow. We've engaged in some level of securities repositioning since the merger. That has been focused on bringing in the duration of our securities portfolio incrementally and focusing on cash flow because a securities portfolio, one of its main purposes is its strong source of liquidity. So that's been the flavor of incremental purchases.
And we're really comfortable with where it's at now, but I think don't be shocked if we were to grow that as a percentage of average assets, perhaps another percentage point or two. There's definitely some certain dynamics relating to the pace of loan growth and whatnot that we consider in sizing it.
But to get back to the original part of the question, the focus in building it has been more on cash flow related securities with that heightened focus on liquidity.
Matthew Olney
On the expense side, I think, Paul, you mentioned maybe a few non-core items in the second quarter. Can you just review those again? I think I just missed those in your prepared remarks.
Just more broadly, the full year guidance, I think we've talked around expenses in that $280 million number. Would love to hear any updated thoughts with respect to that.
Paul Egge
The bogey we target for 2024 is quarterly non-interest expense of $70 million. We were at $71.2 million in the second quarter. The first quarter, we were $71.4 million and that was reflective of some seasonal dynamics. But in the second quarter, we recognized the additional FDIC assessment from SVB. We got the invoice for that during the quarter. So being that that is probable and estimable, we took the accrual on that of $420,000. We had about $450,000 of severance expenses. And then a handful of other kind of not-worth-calling-out small expenses that are non-recurring in nature that generally explain that delta between $71.2 million and really our guidance of $79 a quarter.
Matthew Olney
Maybe just lastly for me, I think Bob has mentioned a few times the CRE concentrations have come down and now you're, I think, within some of the guidelines. Maybe you disclosed that and I just missed it, but can you just give us the percent of – on the guidelines for CRE and C&D that you're at as of June 30?
Robert Franklin, Jr.
We're at about around 95% and 275%. 275%.
Operator
Our next question comes from the line of Andrew with Piper Sandler.
Unidentified Analyst
Just on the credit side, can you detail what drove the minimal net charge-off this quarter as well as what drove the reversal of the provision?
Paul Egge
Could you repeat that, Andrew?
Unidentified Analyst
Just on the credit side, can you detail what drove the minimal net charge-offs and what drove the provision reversal this quarter?
Ramon Vitulli
Well, there was lower outstanding in our CECL formula as we weight certain categories and there's lower outstanding amounts in those categories. That will bring the estimate down. I think the reversal was driven by the fall off in overall loan balances and also we have less in unfunded. Minimal charge-offs, we have some recoveries that were in the quarter, not huge by any means, but we just didn't have much in the way of loans that necessitated charging off. We're taking a real clear-eyed approach to our credit quality. And if a loan needs to be downgraded, it can be downgraded, but we have on our NPAs, we feel like we have strong collateral coverage, and so we feel like there's no need to have an active write-off. We feel pretty good about that. That's what drove that release.
Unidentified Analyst
Just one more for me around capital. Just curious how you're thinking about capital retention versus returning capital to shareholders moving forward.
Robert Franklin, Jr.
Andrew, we're aware of our ability to retain capital. It's something that, since the merger happened, we've been building capital. We're now at a point, I think, where we're comfortable in trying to think about what our options are going forward. We're certainly aware of the various ways we can do that. The biggest thing that we would like to do with our capital is to growth franchise and to help us supplement whatever we choose as far as expanding our franchise. However, we are aware that folks would like us to consider buybacks and dividends, etc.
There's other things that we think we might be able to use this capital for. As we make those considerations through the end of the year, I think it will become apparent as to what our thoughts are around capital. But this isn't a time to be capital constrained. I think this is a time to have a little extra around. We'll see as we move through the rest of the year.
Unidentified Analyst
Congrats on the quarter.
Operator
Our next question comes from the line of John Rodis with Janney.
John Rodis
Just a question for you just to follow up your comments on net interest income bottoming. I assume you're talking about core net interest income excluding yield accretion, is that correct?
Paul Egge
Absolutely, yes.
John Rodis
Okay. And then can you just give us your thoughts on what yield accretion could be in the second half of the year on a quarterly basis or what we should be modeling?
Paul Egge
I'd probably look at the first quarter run rate more than the second quarter run rate. We did benefit from a little bit more in the second quarter. And we're pleased actually. In the second quarter, we got a lot of payoffs and loans that we did not mind seeing payoff and the net result is obviously an increase in that waterfall portion of accretion. So it's really hard to bet on the behavior of loans. Particularly, we've been pleased that some pretty low rate loans are paying off due to sale of property and whatnot, more so than we would have handicapped. So I'd probably guide towards conservatism closer to the first quarter versus the second quarter.
But the good news is we have $87.4 million of loan discount remaining. We feel great about the credit and we're going to recognize that in income as those loans pay down. We see a high level of certainty in that accretion income in the coming quarters.
John Rodis
Just one other question on the tax rate. What's a good – it's ticked up a little bit here, but is 20% still good to use or should we use a little bit higher?
Paul Egge
I would guide you to between 20% and 21%.
Operator
I'll now turn the call back over to Bob Franklin for closing remarks.
Robert Franklin, Jr.
Thank you. We thank all of the great folks here at Stellar Bank for their hard work this past quarter and thank you for your interest in our organization, everyone, on this call.
Operator
Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.