Q4 2023 Stellar Bancorp Inc Earnings Call

Participants

Paul Egge; Chief Financial Officer, Executive Vice President; Stellar Bancorp Inc

Presentation

Operator

Yes, yes, good morning.
My name is Krista, and I'll be your conference operator today. Finally, 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' remarks, there will be a question and answer session questions during that time, simply press star followed by the number one on your telephone keypad. And if you would like to withdraw your question again, press star one. Thank you. I would now like to turn the conference over Courtney Carroll, Chief Accounting Officer. Courtney, you may begin your conference.

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 again, also in attendance today are Steve Retzlaff, Executive Chairman of the Company, Fraser, to Lee, President of the Company and CEO of the bank. I'm 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, and 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 that 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 dot seller Dot 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, 32.

Excuse me.
Thank you, Courtney, and good morning and welcome to the Sterling 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 and for our 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, 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 optimize. 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 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 Evans, 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 130.5 million, representing diluted earnings per share of $2.45 on ROA 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% a year in 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 $17.2 per share at the end of 2023 from $14.2 per share at the end of 2022. During the year, we also maintained a very strong funding profile, marked by 40% noninterest-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 for the quarter and 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 ROA of 1.02% and a return on tangible common equity of 12.61%. This was despite a higher expense load 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-cash expenses more than offsetting higher noninterest income and lower provisions. Notable among noninterest items during the quarter was a nearly 2.4 million in other noninterest income from SDIC. 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 threshold. 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, NAM 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 costs, 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 favorable 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 in a core deposit intangible assets of intangible assets 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 well positioned to perform in 2020 for 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 unknowns 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, Alex. I will now turn the call back over to Bob <unk>, our Vice President

excuse me.
Thank you, Paul. And operator, we'll be happy to take questions.

Question and Answer Session

Operator

As a reminder, if you would like to ask a question, please press star one on your telephone.
Your first question from the line of David Feaster from Raymond James. Please go ahead. Your line is open.

Hey, good morning, everybody. And then on that, maybe just starting out on the 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.

Paul Egge

If we do get cuts this year, we take comfort in that and 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 rates down there is a measure of sensitivity to the front end of the curve, particularly money markets in 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 it really any rate outcome in 2024.

Okay.
That's helpful. And maybe just touching on on the loan declines on actually maybe for another get how do you think about your ability to reprice deposits and the sensitivity of those 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 just curious how you think about repricing some of those deposits are at, including the competitive landscape?

Paul Egge

Yes. I think where you get the most ability to reprice is going to be in your and your exception universe as well as your book naturally the wholesale funding that staying pretty short, you can reprice David up.

I would just add to that the as Paul mentioned that are probably our largest opportunities in that money market where on our 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 calm it down and probably be similar. But we did as we handle the exception pricing, that would be where we would target first 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 would be in that money market bucket.
Okay.

Paul Egge

But I do that just add, as you think about our approach to the deposit side, when the market the market changed and people were really aggressive about trying to fund our balance sheets. We felt like we didn't want to get into that competition. It was above 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. And so we just won we won rates to level out or give us some kind of idea that we're not going to be paying outsized prices for leasing.

Okay.
That's helpful. And maybe just touching on on the loan side and the declines in the core. 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, just your appetite for growth today where you're seeing opportunities and kind of where we're pricing pricing home, then I think it's a it's a combination of both that you mentioned both our underwriting approach as well as some demand of pressure and that our customers are trying to get used to this rate environment.

And so we're seeing it on both fronts. We have from a number of quarters in a row or where our eye on 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&I has increased a little bit in the fourth quarter, we did drop a little bit compared to the third quarter and total originations, but feel real good about where those came on at rates still with an eight handle on our new loans and dumb, we renewed another $600 million come also with an eight handle. So we're pretty pleased with that as well.

Okay, terrific.
That's great.
Last one for me. Maybe just touching on the expense side, core expenses ticked up a bit of 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? I'm curious how you think about that?

Paul Egge

We guide to 2024 expected expense on a core basis of around 280 million. And there's a lot of drivers that we're going to be focused on 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 and all and to pursue the initiatives we want to pursue in 2024 to position us best. And that's that's the spend level in the plan. Now the first quarter tends to be had some seasonality to it that that's going to drive going to be a little higher than if you were to divide that by four arm, but that's where we're targeting.

Terrific. Thanks, everybody for CyberKnife.

Operator

Our next question comes from the line of Matthew only from Stephens. Please go ahead. Your line is open.

Hey, great.
Thanks, one everybody. Remember, Matt, I'll start on the professional fees. I think Paul mentioned professional fees was elevated due to some these initiatives of crossing $10 billion of assets and any more color on these initiatives? And then how do you see that line item trending in 2024?

Paul Egge

And again, it's more of a timing dynamic. If you saw the third quarter was relatively with a dip from the second quarter and a lot of work has been done here in the fourth quarter to kind of achieve the goals. We wanted to achieve by the end of the year as it relates to on all things in the new standards of being over $10 billion in assets.
Now when we look forward, we think about a run rate of professional fees that would be on?
Yes, certainly lower than the fourth quarter. I'd probably say more like $2.5 million, but that has some timing variation on a quarterly basis, similar to what we saw in our trend. When you look at that line from the second quarter to the third quarter and the fourth quarter.

Okay. And I assume that's all embedded in that 24 guidance you mentioned, Paul, of the 280 million.

Paul Egge

Exactly.

Okay. That's helpful on. And then I guess switching over to the loan yields, if I take out the accretion levels, I'm getting a pretty nice uptick in the core core loan yields. Any color on the drivers there.
And then just remind us on the fixed rate loan repricing dynamics of the bank, remind us what you expect to reprice higher during the year? And I heard heard Ray mentioned, some of these newer yields are still at the 8% level.

Just remind us on kind of on the price dynamic what they're coming from and in some cases, banks Matt, on the on the renewed loans, we've been we've been we have a run rate of around 600 million a quarter of of renewed loans. And so for the fourth quarter, those came on at eight renewed at eight 51 coming off of seven 79. So yes, I think going forward, it's a little we'll probably get closer obviously, but probably coming off of something in the sevens and then renewing at something in the eights is what we would expect.
And then again, on the new this, the new was 200, 50 million of new loans that came on at 8%. So and that helps you with your what you're expecting in the fixed rate repricing mean that obviously there's fixed and floating in that 600 million that I'm referring to so that I don't have I'm handy the what the fixed rate portion of that is.

Yes, that's that's helpful. I guess you mentioned the floating portion. And I think in our models, we're all assuming various on various themes behind what the Fed does this year. Remind us of what's what's floating at the bank and if that were to could at some point this year, just a dollar amount of loans that would reprice downward pretty quickly from the from the from the yield side

Paul Egge

around a little over 40% is variable, but truly floating if you're talking about a little over 20%.
So that's what will move more immediately relative to our at that time. So for in particular?
Yes, David, we had debt.

Okay.
Perfect.
And then on the deposit side, you hit on some levers you can pull there. If rates were to move lower.
What about on the non-interest bearing side, a little bit of give up in the fourth quarter, but still one of the one of the kind of highest levels amongst the peers.

Paul Egge

Any more color or thoughts on where you see balances are kind of stabilizing and what time line we see, I would ask you to look at the average for the quarter at some point in time at 1231, it looks like it would appear that we went from kind of 42% or 41.5% to two right at 40% on that NIB ratio. But if you take it more on an average basis or if you were to say point in time today, have we we have enjoyed around 41 or so percent we have deposits. And so far, we're really, really pleased with the resilience of that holding up a little bit of what occurred at 1231 in particular, was a large growth in the interest-bearing demand and that that when that piece grows new, you obviously kind of drowned out the NIB and NIB actually point to point was slightly down. So we're really pleased with the resilience of our non-interest bearing our portfolio of customers, and we look forward to maintaining really strong proportion of nib going forward.

Okay, guys, appreciate all the commentary and congrats on the quarter.

Nice mathematics.

Operator

If you'd like to ask a question, please press star one on your telephone keypad. Your next question comes from the line of John Rodis from Janney Montgomery Scott. Please go ahead. Your line is open.

Hey, good morning, guys for the time and just looking at switching gears, looking at fee income, what was the SVICD. impact in the quarter?

Paul Egge

2.4 million. We recognized 2.4 million of revenue on that SBIC. gain?

And how should we I mean that's not really or I know you have it sometimes, but how should we think about that going forward?

Paul Egge

Yes, we since we can't sell our watch to how we recognize gains there. And we are very active conservative as it relates to how we think about that source of revenue. So I would add look at our noninterest expense base ex 2.4 million and and think about that as our Arm paid in 2024.

Okay.

And then all we are always working. We are always working on initiatives to build that on and right now I've read that. Can you speak to that, Paul?

Just one other question on fee income. The card fees were down, I don't know, about 400,000 from the third quarter. Anything going on there?
How should we think about that number going forward,

Okay. interchange or Durbin fees that's our Durbin impact. So I'm just working working hard as a team to to have more more penetration of our cards to trying to overcome that. And we've seen good really good story on our new account onboarding. And so I'm just helped the growth grow through that and overcome those that decrease. We've had some government.

But that's but the hit was started in the third quarter. So it was down and then it was down even some more in the fourth quarter.
So.
Okay, yes, but there's nothing unusual or outside of Durban in that line item?

Paul Egge

Yes,
no, but we have been we have observed that the impact of Durbin was a little bit higher than fee initially estimated.

Okay.
And then just one other question, guys. I guess I know this is a little bit harder, but just on the provisioning, how maybe how should we think about provision level going forward?

Paul Egge

Well, our formula-driven guidance?
No, it's very based on what happens with the loan portfolio good or bad. And what the increases in our portfolio are will drive drive loan provision. And it's hard to project them almost as hard as interest rates.
I'm hearing that we do expect credit. We are we have a conservative stance on credit, especially given our economic unknowns. So where the way we've planned is for a more normalized level of charge-offs in the industry in 2024, and that obviously plays into reserves.

Paul, what would it would when you say normal, what do you think is more normal?

Paul Egge

And I would think normal to elevate it will be for us. Both legacy companies have been able to maintain for the most part it single digit net charge-off numbers. But when you think about industry and what's a prudent expectation to set when there is an expectation of a credit cycle, finally hitting the industry, you have to assume something in the high 10s, low 20s in net charge-offs just to provide a little bit of a baseline and we feel really good about our ability on a relative basis because of where we operate to do better than whatever the industry nationwide metrics end up being.

Okay.
Thanks for the thoughts.
And Paul, just one other question the tax rate is around 20%, still a good number.

Paul Egge

Yes.
Thank you, guys.

Operator

And your next question comes from the line of Matthew only from Stephens. Please go ahead.
Your line is open.

Yes, guys, thanks for the follow up on. I just want to go back to the core margin where we saw the stabilization in the fourth quarter. I think if you take out the accretion levels, I think a quarter ago you were a little hesitant to call for the bottom, but assuming the Fed holds off on any moves for a few quarters. Any color on kind of what's the confidence level that the core NIM. hasn't that bottomed here in the fourth quarter?

Paul Egge

You know, it's a real uncertain backdrop, I you're going to you don't have a hard time teasing out a or a bottom out of us, but we feel really good about how positioned we are to defend our margin and defend our net interest income and add you have let the results speak for themselves.

Okay. And then on the capital front, I think Paul maybe was your prepared remarks some on the call, lots of good capital build, not just in the fourth quarter, but also throughout the year on any updated thoughts around deployment this year. It could this be a year of leading the stock buybacks? Or do you think the environment for something more significant is something you want to focus on and maybe buybacks take a backseat this year, Matt, I think we spent a lot of time making sure that we build capital levels back to where everyone feels a lot more comfortable and give us optionality on the things that we want to do.

And so we want to have as many options available to us as possible and capital provides that. And it will be interesting to see how the year plays out. I know there's a lot of expectation of rates coming down. I don't know if that's going to be the case or not. I think the economy still seems to be clipping along, okay.
Although there's a little probably going to have some slowdown at some point during the year. But And and so I think until we get a little more certainty around around where interest rates are and what the economy is going to do. We're going to continue on the same path that we've been on, but all this is and is leading into making sure that we have optionality. And if we have the opportunity, whether it's buybacks and M&A, whatever the whatever the deployment might be of that capital dividend and we want all of those options available to us and look well trying to choose the right one for the shareholder.

Okay, thanks.
Thanks for that, Bob. And let me ask it this way, the capital levels built really nicely in 23. It looks like they're going to build considerably in 24 absent any kind of are there other actions would that be acceptable you think for capital level to continue to build? Or at what point did you feel more urgency to deploy capital in trying to figure out this is something where we're getting close to that or given the uncertainty we could, we could let capital levels build here for a while before we spill any any urgency to deploy it of that?

That's a great question, Matt. I enjoyed Josh, if you if we think about where where we might be from an economy standpoint of it, if life comes true and we get five interest rate cuts this year or whatever somebody might project to me, that means unemployment's gone up, economy slowing down, maybe credit starts to move in a certain way I don't know. I don't think there's much certainty around if interest rates stay the way they are. Maybe a couple of small cuts gives us a better. And I think we'll have more clarity as we move into the second third quarter. And but we're not, I guess, buybacks, we actually like buybacks. And but we want to make sure that we have a good solid capital base to operate on that. No one is a question harm our ability to do what we want to do, and we want to keep our options open and we will we certainly understand what we can do with that capital, and we're going to we're going to do the best thing for the shareholders.

Okay, guys, appreciate all the commentary and have you guys in a few weeks later,

Operator

we have no further questions in our queue at this time.
I will now turn the call over to Bob Franklin, Chief Executive Officer for closing remarks.

And thank you, everyone, for their interest today, and we look forward to 2024% and continuing to build stellar bank in a great way Thank you very much.

Operator

Concludes today's conference call. Thank you for your participation, and you may now disconnect.