Q2 2024 Stellar Bancorp Inc Earnings Call

Thank you for standing by. At this time, I'd like to welcome everyone to the Stellar Bancorp Inc Q2 2024 earnings call.

Operator: Inc. Q2 2024 earnings call. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press star followed by the number one on your telephone keypad. Thank you. I'd now like to turn the call over to Courtney Theriot, Chief Accounting Officer. Please go ahead.

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 star followed by the number one on your telephone keypad. 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.

Courtney Theriot: Thank you, Operator, and thank you all that have joined our call today.

Speaker Change: Good morning. Our team would like to welcome you to our earnings call for the second quarter of 2024.

Speaker Change: This morning's earnings call will be led by our CEO , Bob Franklin, and CFO , Paul Egge.

Speaker Change: Also in attendance today are Steve Retzlaff, 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.

Speaker Change: 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.

Speaker Change: 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.

Speaker Change: We do claim any obligation to publicly update any forward-looking statement, except as may be required by law.

Speaker Change: Please see the last page of the text in this morning's earnings release, which is available on our website at ir.stellarbancorp.com for additional information about the risk factors associated with forward-looking statements.

Courtney Theriot: 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 Retzlaff, 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.

Speaker Change: 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.

Courtney Theriot: 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.

Robert R. Franklin: Thank you, Courtney, and good morning, and welcome to the Stellar Bancorp earnings call for the second quarter.

Courtney Theriot: 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.stellarbancorp.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 R. Franklin: We are pleased to report our results that represent the great work of the Stellar team.

Robert R. Franklin: 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, which 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 regulatory guidance, and our goal is to manage and maintain these levels moving forward.

Robert R. Franklin: 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.

Robert R. Franklin: Our commercial real estate portfolio is now within the regulatory guidance and our goal is to manage and maintain these levels moving forward.

Robert R. Franklin: 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.

Robert R. Franklin: While our focus has always been and will remain on relationship banking, we are taking a more balanced approach to our lending.

Robert R. Franklin: 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.

Robert R. Franklin: We have added great personnel to our staff to lead these efforts across our footprint. We are pleased with the success of our officer development program and how it has supplemented our C&I efforts. We look forward to great results from them over the years to come. However, 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.

Robert R. Franklin: We have added great personnel to our staff to lead these efforts across our footprint. 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.

Robert R. Franklin: 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.

Robert R. Franklin: Our goal has been to provide Stellar Bank with optionality and its 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.

Speaker Change: Our goal has been to provide Stellar Bank optionality and its strategic goals by building a strong deposit base, maintaining a good net interest margin, and building our capital base.

Speaker Change: We believe this positions us to take advantage of opportunities as they present themselves moving into and through 2025.

Speaker Change: 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 P. Egge: Thanks, Bob. And good morning, everybody.

Paul P. Egge: We are pleased to report second quarter net income of $29.8 million, or 56 cents per diluted share, which represents an annualized ROAA of 1.13% in an annualized ROATCE of 12.82% as compared to first quarter earnings of $26.1 million, or 49 cents per diluted share, which resulted in an ROEA 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 optimizing 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 and build a more liquid balance sheet in a crew cabin.

Paul P. 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

Paul P. Egge: of 12.82% as compared to first quarter earnings of $26.1 million or 49 cents per diluted share, which made for an REA of 0.98% and a return on average tangible common equity of 11.47%.

Paul P. Egge: 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.

Paul P. Egge: The net result has been a lower emphasis on loan growth as we seek to diversify our lending business.

Paul P. Egge: Build a more liquid balance sheet in accrued capital.

Paul P. Egge: 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 4.2%. 6% in the first quarter of 2024.

Paul P. Egge: 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.

Paul P. Egge: So net interest income for the quarter was $101.4 million.

Paul P. Egge: Representing a decrease of about $700,000 from $102.1 million booked in the first quarter of 2024.

Paul P. Egge: This translated into a net interest margin of 4.24% in the second quarter relative to 4.26% in the first quarter of 2024.

Paul P. Egge: Purchase accounting accretion with $10.1 million relative to $18.2, $8.6 million in the prior quarter. Excluding personal accounting accretion, net interest margin was 3.82%, down from 3.91% in the linked quarter and reflective of the full quarter margin impact of the funding makeshift that we experienced in the first quarter. Notwithstanding the mixed-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.

Paul P. Egge: Purchased accounting accretion with $10.1 million relative to $8.6 million in the prior quarter.

Paul P. Egge: Excluding personal accounting accretion, net interest margin was 3.82%, down from 3.91% in the length quarter, and reflected the full quarter margin impact of the funding mix shift that we experienced in the first quarter.

Paul P. Egge: Now, withstanding the mixed-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.

Paul P. Egge: 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 FDB in 2023 and the cumulative effects of the rate cycle.

Paul P. Egge: And we feel really good about how our level of non-interest-bearing deposits has stabilized after seeing outflows in the aftermath of SBB in 2023 and the cumulative effects of the rates. 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 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 a lower loan balance. And since annualized net charge-offs were negligible and loan balances decreased, our allowance for credit losses actually ticked up to 1.23% of total loans from 1.22% in the prior quarter, notwithstanding that reversal.

Paul P. Egge: 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.

Speaker Change: 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.

Speaker Change: It's mostly due to stable credit and lower loan balances.

Speaker Change: And since annualized net charge-offs were negligible and loan balances decreased, our allowance for credit losses actually ticked up to 1.23% of total loans from 1.22% in the prior quarter, notwithstanding that reversal.

Paul P. Egge: Moving on to non-interest income, we earned $5.4 million for the quarter versus $6.3 million in the first quarter. However, I should note that the prior quarter benefited from nearly a half-million dollar gain on the sale assets and some FBIC income. 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 an 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.

Speaker Change: Moving on to non-interest income, we earned $5.4 million for the quarter versus $6.3 million in the first quarter.

Speaker Change: I should note that the prior quarter benefited from nearly a half a million dollar gain on the sale of assets and some FBIC income in the quarter.

Speaker Change: 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.

Speaker Change: Excluding notable non-recurring items such as additional FDIC special assessment charge that totaled $420,000 and approximately $450,000 of severance.

Speaker Change: and certain other items, our non-interest expense was generally in line with our expectations for the quarter.

Paul P. Egge: 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.

Speaker Change: Given cumulative industry pressures and our position at just over $10 billion in assets.

Speaker Change: 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.

Speaker Change: 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.

Paul P. Egge: 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 process has been, and 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 prospect for internal capital generation, which we feel is very strategically valuable in the current operating environment.

Speaker Change: 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.

Speaker Change: This process 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,

Speaker Change: notwithstanding a very accelerated amortization of CDI expense.

Speaker Change: We continue to like our prospects for internal capital generation, which we feel is very strategically valuable in the current operating environment.

Paul P. Egge: We ended the quarter with $104.3 million in quarter positive 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.

Speaker Change: We ended the quarter with $104.3 million in quarter positive and tangible assets.

Speaker Change: and a remaining loan discount of $87.4 million.

Speaker Change: 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.

Speaker Change: The incredible strength and resilience of our market.

Speaker Change: is advantageous from a credit standpoint and will prove just as advantageous when the time is right to be more assertive about loan growth.

Paul P. Egge: We believe our strategic positioning as the largest locally focused bank in the markets we serve will continue to drive our success through the remainder of 2024 and beyond. Thank you, and I will now turn the call back over to Bob.

Speaker Change: 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.

Robert R. Franklin: Thank you, Paul and operator. I think we're ready to take questions.

Speaker Change: Thank you and I will now turn the call back over to Bob.

Robert R. Franklin: Thank you, Paul and operator. I think we're ready to take questions.

Operator: At this time, I'd like to remind everyone to ask a question; press star one on your telephone keypad. Our first question comes from the line of David Feaster from Raymond James. Your line is open.

Speaker Change: At this time, I'd like to remind everyone to ask a question, press star one on your telephone keypad. Our first question comes from the line of David Feaster from Raymond James. Your line is open.

David Pipkin Feaster: Hey, good morning, everybody. Um, maybe I should start 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 giving less appetite for CRE at this point, and maybe, you know, tightening structures and standards ahead of a potential credit cycle versus weaker demand and pay, or increased payoff activity. Just kind of curious if you could help us think through what drove that and your appetite for credit today.

David Pipkin Feaster: Hey, good morning, everybody.

David Pipkin Feaster: David Morgan. David Morgan. David Morgan. Maybe just starting with the decline in loans. I'm curious if you could help us.

Speaker Change: You know, think through through what's going on, how much of this is is strategic, just giving less appetite for CRE at this point, and maybe, you know, tightening structures and standards ahead of a potential credit cycle versus

Speaker Change: Weaker Demand or Increased Payoff Activity. I'm just kind of curious if you could help us think through what drove that and your appetite for credit today.

Robert R. Franklin: David, I think you may have answered your own question there. That's pretty much... We've we we had a 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 to get 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.

Speaker Change: David, I think you may have answered your own question there. That's pretty much.

Speaker Change: We had a, 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.

Speaker Change: For a number of reasons to doubt under the guidance. So we've accomplished that at this point.

Robert R. Franklin: And we've been cautious. I mean, we have been cautious this year around what the damage to the economy is going to be from interest rates. And I'm not sure we've totally experienced that yet in the markets, but our market continues to be good. Loan demand, I would say, is still okay. It's still there, but it's certainly not as 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.

Speaker Change: and are starting sort of a more balanced effort as we start to grow the portfolio back.

Speaker Change: And we've been cautious. I mean, we have been cautious this year around what the damage to the economy is going to be around interest rates, and I'm, I'm not sure we've totally experienced that.

Speaker Change: yet in the markets. But our market continues to be good. Loan demand, I would say, is still okay. But it's certainly not as robust as it had been

Speaker Change: say earlier in the year or even last year, so.

Speaker Change: I'm going to let Ray make some comments on this because he's got some good information, I think.

Ramon A. Vitulli: Yeah, David, in addition to what Bob said, as far as 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 to around $250, so that was about $50 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 a quarter in payoffs.

Ray: Yeah, David, in addition to what Bob said, as far as like the waterfall of how we got there in the quarter.

Ray: We've been originating around $300 million for the last four quarters.

Ramon A. Vitulli: And the first quarter was $320, 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 are, 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 payment exceeding advances, which is probably what we'll see until we take a more offensive approach.

Ray: But the second quarter was down to around 250, so that was about 50 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 a quarter in payoffs.

Ray: The first quarter was $3.20, so those are elevated payoffs. And then the other component, which we call our carried, which is our advances net of our payments.

Ray: because of where we've, the posture we've taken around C&D and that availability and that bucket going down.

Ray: That carried actually flipped to the negative, so we actually had about a $30 million payment exceeding advances, which is probably what we'll see until we take a more offensive approach.

Robert R. Franklin: Okay, so it kind of sounds like loans are treading water here.

Speaker Change: Okay, okay, so it kind of sounds like loans tread in water here.

Robert R. Franklin: Stabilized, I think, and you know, 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 fund out, we haven't been replacing them in as robust a fashion as we had.

Speaker Change: Stabilizing.

Speaker Change: Stabilized, I think, and, you know, we're making this transition to a little more balanced approach and a little more emphasis on C&I.

Speaker Change: We've also brought down the C&D part of that, so as these construction loans funded out.

Speaker Change: We haven't been replacing them in as robust a fashion as we had in the past.

Robert R. Franklin: A couple years ago, but 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 the presidential election to 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 comfortable with that, that's exactly what we'll be doing. And our markets continue to grow, and we continue to see job growth, and population growth here. And, you know, I just think the future is really good for this franchise.

Speaker Change: A couple of years ago, but so it's really a more balanced approach on how we grow the organization. And I think.

Speaker Change: We get through sort of all the noise in the marketplace from interest rates to presidential election to all the other things that are going on out there that we are well positioned to move forward.

Speaker Change: 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, you know, I just think the future is really good for this franchise.

David Pipkin Feaster: That's great, and great to see, well, maybe staying on that kind of side, you know, 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, you know, deepening your presence or potentially, you know, interested in market expansion at all? I'm just kind of curious what you're thinking on the hiring front.

Speaker Change: That's great. And great to see, well, maybe staying on that kind of side, you know, you've historically had a lot of success recruiting talent. I'm curious, maybe what you're seeing on the hiring front.

Speaker Change: 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're thinking on the hiring front.

Robert R. Franklin: Hiring on the front line 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, our 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 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 board. And we're going to continue to do that. We're continuing to look for talent, all across the board.

Speaker Change: Hiring Front has been really good. We've been able to attract some great senior C&I talent.

Speaker Change: that is just getting their feet wet and and and getting going. We're producing our own through our ODP program officer development program.

Speaker Change: and pushing those folks towards the C&I side of the business, and I think that's going to pay off.

Speaker Change: As we move down the road, but.

Speaker Change: 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.

Speaker Change: Continuing to look for talent all across the board.

David Pipkin Feaster: And then last for me, just great stabilization in NIB balances, especially with some of the delivery of CNI 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, you know, 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?

Speaker Change: That's great.

Speaker Change: And then last for me, just stabilization in NIB balances, especially, you know, with some of the delivering 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 a

Speaker Change: you know, 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?

Paul P. Egge: Yeah, David, we looked at the leading indicator on our new accounts onboarded, and it's had another strong quarter. In fact, the dollar amount was one of the highest quarters of new, new onboarded accounts that we've had in four quarters. So really pleased there.

Speaker Change: Yeah, David, I think the, you know, we look at the leading indicator on our new accounts onboarded.

Paul P. Egge: And the other component of that, what's really exciting about it, is that 55% of those onboarded number of accounts were new customers. So I think that reflects on our bankers out in the field, as well as on our brand. And inside of that, Of the non-interest bearing new accounts, 69% of the non-interest bearing accounts were customers that had not been here before. So we think those are great trends, and I think that, as we move forward and those accounts build, because they start typically at a lower balance, obviously, that will result in what you're talking about, of how we maintain this level of NIB and also maintain or deal with our cost of funds.

Speaker Change: And it's had another strong quarter. In fact, dollar amount was one of the highest quarters of new, new onboarded accounts that we've had in four quarters. So really pleased there. And the other component of that, what's really excited about is that

Speaker Change: 55% of those on-boarded number of accounts were new customers. So I think that reflects on our bankers out in the field, as well as our brand. And inside of that,

Speaker Change: of the non-interest bearing new accounts.

Speaker Change: 69% of the non-interest bearing were customers that have not been here before. So.

Speaker Change: 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 maintain this level of growth.

Speaker Change: of MIB and also maintain our or deal with our cost of funds.

Paul P. Egge: Yeah, David, we've been trying to wait to a point where some of the noise and interest rates, especially on the deposit side, get drowned out a bit. And I think we're starting to see stabilization across the industry where 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.

David Pipkin Feaster: Yeah, David, we've, we've, we've been trying to wait to a point where some of the noise and interest rates, especially on the deposit side.

David Pipkin Feaster: get drowned out a bit. And I think we're starting to see stabilization across the industry. We're not seeing

David Pipkin Feaster: Reaches for higher and higher interest rates.

David Pipkin Feaster: 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.

Paul P. Egge: And that's been our background. And so we think that it's starting to change 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. That's great.

David Pipkin Feaster: 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.

David Pipkin Feaster: That's great. Thanks, everybody.

Speaker Change: That's great. Thanks, everybody.

Operator: Our next question comes from the line of Will Jones at KBW. Your line is open.

David Pipkin Feaster: Thank you, David.

Speaker Change: Our next question comes from the line of Will Jones at KBW. Your line is open.

William Bradford Jones: Hey, great. Good morning, everyone. Hey, Paul.

William Bradford Jones: So I just wanted to start on the margin and maybe more specifically deposit costs. You know, it was a bit surprising maybe to see a little bit of an acceleration this quarter in deposit costs. It's just after, you know, 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 a liquidity build.

William Bradford Jones: Hey, great. Good morning, everyone. Farewell.

William Bradford Jones: Hey, Paul, so I just wanted to start on the margin and maybe more specifically deposit costs. You know, it was a bit surprising maybe to see a little bit of an acceleration this quarter.

Speaker Change: and deposit costs just after, you know, 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 a liquidity build.

William Bradford Jones: I guess the question is, is that kind of a little bit of the driver of this quarter's change? And then there's been a broader narrative this quarter that, yes, maybe deposit costs continued 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?

Speaker Change: I guess question is, is that kind of a little bit of the driver of this quarter's change and then, you know, 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.

Speaker Change: Would you guys kind of describe that as the trend for your deposit cost this quarter?

Paul P. Egge: Now, I'll start with the drivers of margin, and I would say, really, the big driver that caused it 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 quarter is where you saw where we experienced a measure of non-interest bearing outflows, and that kind of The really good news is the extent to which it's been rather stable, so we have experienced up to this point, if we were to review it kind of on a month-to-month basis, a pretty high level of stability in the cost of funds.

Speaker Change: Now I'll start with the drivers of margin and I would say

Speaker Change: Really.

Speaker Change: the big driver that caused the...

Speaker Change: It 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

Speaker Change: shifted during the first quarter of 2024. So probably around mid, mid quarter, mid to late quarters, where you saw where we experienced a measure of non-issue bearing outflows. And that

Speaker Change: kind of resetting the deck and effectively replacing non-interest bearing balances with interest bearing balances is ultimately what drove kind of a higher

Speaker Change: entrance cost of funds in the second quarter. The really good news is the extent to which has been rather stable. So we have experienced up to this point, and for the review kind of on a month to month basis, a pretty high level of stability and cost of funds. In fact, probably

Paul P. Egge: In fact, probably one of the worst cost of funds months was likely April, but it has been relatively stable, and it hasn't improved that materially, but we're pleased to be experiencing it. We have experienced relative stability and have experienced monthly stability throughout the second quarter.

Speaker Change: One of the

Speaker Change: The worst cost of funds month was likely April , but it has been relatively stable and it hasn't improved that materially, but we're pleased to be experiencing it.

Speaker Change: experiencing relative stability and have experienced monthly stability throughout the second quarter.

William Bradford Jones: Great, so if we just kind of pair that commentary, maybe we see deposit cost stabilize here. And, you know, just with the expectation that NII, you know, troughs this quarter and expands from here on out, would you expect, you know, margin stability going forward? Or, you know, is there opportunity to maybe see a bit of expansion as we exit the year?

Speaker Change: [inaudible]

Speaker Change: So if we just kind of pair that commentary, maybe we see deposit cost stabilize here and you know, just with the expectation that NII, you know, troughs this quarter and expands from here on out, would you expect?

Speaker Change: you know, margin stability going forward? Or, you know, is there opportunity to maybe see a bit of expansion as we exit the year?

Paul P. Egge: I think stability is better than expansion. I'd actually rather speak in terms of net interest income. It's kind of where we are, we're, we're more confident in the trough by virtue of, you know, some, as we build some 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 dilute 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 influx because of some of the inherently dilutive effects of building liquidity on our balance sheet.

Speaker Change: I think.

Speaker Change: Stability to Expansion.

Speaker Change: I'd actually rather speak in net interest income terms. It's kind of where we're, we're, we're more competent on the trough by virtue of

Speaker Change: You know some as we build some on balance sheet liquidity and pivot to a larger securities portfolio and whatnot that

Speaker Change: 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

Speaker Change: before the metric of net interest margin inflects because of some of the inherently dilutive effects of building liquidity on the balance sheet to that statistic.

William Bradford Jones: That's great. I appreciate that.

Speaker Change: That's great, Paul, I appreciate that.

Speaker Change: And Bob, just a bigger, broader question for you, you know, we've talked about, you know, quite a bit about, you know, your hiring opportunities and what you're doing internally and reinvesting just just from an organic standpoint, but

Speaker Change: 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 R. Franklin: And Bob, just a bigger, broader question for you. You know, we've talked about 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 R. Franklin: 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...

Robert R. Franklin: Yeah, I think there continues to be a lot of conversations across the industry, and we're having a significant number of conversations ourselves. You know, one of the things that we always worry about is how what is a future acquisition target will look like and the way they fund themselves.

Speaker Change: How does a future acquisition target look?

Robert R. Franklin: 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.

Speaker Change: and the way they fund themselves. And the biggest focus for us is trying to maintain the funding profile that we have.

Speaker Change: which is difficult, and it's hard to find good partners that kind of look the same way.

Speaker Change: We feel very strongly that that's the value created for shareholders is around the deposit side, especially as we keep as we as we move forward, I think it's becoming more and more important every day. And so we

Robert R. Franklin: And so we The field gets narrowed a bit on who our acquisition targets might be, but we're having a lot of conversations. There are 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 the right choice is to find the right partner. And we intend to be the partner that they choose when they come around to deciding that they want to make that exit.

Speaker Change: The field gets narrowed a bit on who our acquisition targets might be.

Speaker Change: But we're having a lot of conversations. There's several folks that I think are starting to understand the difficulties going forward and the valuations.

Speaker Change: May not be exactly what their expectations were going to be, but maybe the right choice is to find the right partner.

Speaker Change: And we intend to be the partner that they choose when they come around to deciding they want to make that exit.

William Bradford Jones: I certainly understand wanting to maintain that attractive funding profile. So I appreciate all the color guys. That's all.

Speaker Change: I certainly understand wanting to maintain that attractive funding profile, so I appreciate all the call guys. That's all from me.

Operator: Again, if you'd like to ask a question, press star one on your telephone keypad. And our next question comes from the line of Matthew Olney from Stevens. Your line is open.

Speaker Change: Thank you.

Speaker Change: Again, if you'd like to ask a question, press star one on your telephone keypad. And our next question comes from the line of Matthew Olney from Stevens. Your line is open.

Matthew Covington Olney: Hey, thanks. Good morning, everybody, and Matt. Paul, I want to go back to something you mentioned earlier.

Speaker Change: Hey, thanks. Good morning, everybody. Hey, Matt.

Matthew Covington Olney: You mentioned building a larger securities portfolio, and we saw some of this in 1Q and 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.

Speaker Change: Paul, I want to go back to something you mentioned earlier. You mentioned building a larger...

Matthew Covington Olney: 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.

Paul P. Egge: Certainly. We've been giving them very, very vanilla, low-risk-weighted agency securities. Really changing to a focus on 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 our securities portfolio, one of its main purposes is a strong source of liquidity. So that's in the flavor of incremental purchases. And we're really comfortable with where it's at now, but I think you wouldn't be shocked if we were to grow that as a percentage of average assets, perhaps another percentage point or two.

Speaker Change: Build of that portfolio in the back half of the year.

Speaker Change: Certainly. We've been keeping it very, very vanilla, low-risk-weighted agency securities.

Speaker Change: Really changing to a focus of cash flow with engaging 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

Speaker Change: Security's portfolio, one of its main purposes is a 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.

Speaker Change: at the Percentage of Average Assets.

Paul P. Egge: There's definitely some dynamics, 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.

Speaker Change: Perhaps another percentage point or two. There's definitely some

Speaker Change: dynamic, certain dynamics relating to

Speaker Change: The pace of loan growth and whatnot that we consider in sizing it.

Speaker Change: 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 Covington Olney: Okay. Thanks for that, Paul.

Speaker Change: Okay.

Matthew Covington Olney: And then 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. And then, just more broadly, the full year guidance. I think we've talked about expenses in that 280 number. We'd love to hear any updated thoughts with respect to that.

Speaker Change: Thanks for that, Paul.

Speaker Change: And then on the expense side, I think, Paul, you mentioned maybe a few non-core items in the second quarter. Can you just...

Speaker Change: Review those again. I think I just missed those in your prepared remarks. And then just more broadly, the full year guidance. I think we've talked around expenses in that 280 number. We'd love to hear any updated thoughts with respect to that.

Paul P. Egge: Yeah, you know, the bogeyman we target for 2024 is quarterly non-expensive $70 million. We were at $71.2 million in the second quarter. In the first quarter, we were $71.4 million, and that was reflective of some seasonal dynamics. In the second quarter, we did have, and we recognized the additional FDIC assessment from SCB. We got the invoice for that during the quarter, so being that that is probable and estimable, we took the accrual on that for $420,000.

Paul: Yeah, you know, the bogey we target for 2024 is

Speaker Change: quarterly non-expensive $70 million. We were at $71.2 million in the second quarter. In the first quarter, we were $71.4 million. And that was reflective of some seasonal dynamics. But in the second quarter, we did have, we recognized

Speaker Change: The additional FDIC assessment from SCB, 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

Paul P. Egge: 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-occurring in nature that generally explain that delta between $71.2 and really our guidance of $70 million a quarter.

Speaker Change: We had about $450,000 in severance expenses, and then a handful of other kind of

Speaker Change: Not worth calling out, small expenses that are non-occurring in nature that generally explain that delta between 71.2 and really our guidance of 70 million bucks a quarter.

Matthew Covington Olney: Okay, got it. And then maybe just lastly for me, I think Bob has mentioned a few times that the CRE concentrations have come down, and now you're, I think, within some of the guidelines. Maybe if it's closing there, I just missed it, but can you just give us the percent of the guidelines for CRE and CND that you're at as of June 30? Yeah, we're about

Speaker Change: Okay, got it.

Speaker Change: And then maybe just lastly for me, I think Bob's mentioned a few times the

Speaker Change: The CRE concentrations have come down and now you're I think within some of the guidelines. Maybe it's just closing there, I just missed it, but can you just give us that the percent of on the guidelines for CRE and CND that you're at as of as of June 30?

Paul P. Egge: Yeah, we're about right on 95% and 275%.

Speaker Change: Yeah, we're about right on 95% and 275%, 275.

Matthew Covington Olney: Thanks Matt. Thanks Matt.

Speaker Change: Okay, perfect.

Speaker Change: Thanks guys.

Operator: Our next question comes from the line of Andrew with Piper Sandler. Your line is open.

Matt: Thanks Matt.

Speaker Change: Our next question comes from the line of Andrew with Piper Sandler. Your line is open.

Andrew: Hey, good morning.

Andrew: 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?

Andrew: Good morning.

Andrew: 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?

Andrew: Could you repeat that, Andrew?

Andrew: Sure. Just on the credit side, can you detail what drove the minimum net charge-off and what drove the provision reversal this quarter?

Speaker Change: I can catch all

Speaker Change: Could you repeat that Andrew?

Andrew: Sure, just on the credit side, can you detail what drove the minimum net charge off and what drove the provision reversal this quarter?

Paul P. Egge: Well, there were lower outstandings in our CECL formula as we weight certain categories. There are lower outstanding amounts in those categories, that will, you know, bring the estimate down. So I think the reversal was driven by the fall off and overall loan balances. And also, we have less in unfunded. Now, minimal charge-offs is we just, we had 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.

Speaker Change: Well, there was lower outstandings in our CECL formula as we weight certain categories. There's lower outstanding amounts in those categories.

Speaker Change: that will, you know...

Speaker Change: bring the estimate down. So I think it was the reversal was driven by the fall off of overall loan balances.

Speaker Change: And also the, you know, we have less in.

Speaker Change: And on Sunday, now, minimal charge-offs is, we just, we had 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.

Paul P. Egge: 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. So we feel like there's no need to have an active write-off. So we've got, we feel pretty good about that. So that's what drove that release.

Speaker Change: 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.

Speaker Change: So, we feel like there's no need to have an active write-off

Speaker Change: So we've got, we feel pretty good about that. So that's what drove that release.

Andrew: Okay, that's helpful. Thank you. And then just one more question around capital. I'm just curious how you're thinking about capital retention versus returning capital to shareholders moving forward. Thank you.

Speaker Change: Okay, that's helpful. Thank you. And then just one more for me around capital. Just curious how you're thinking about capital retention versus returning capital to shareholders moving forward. Thank you.

Robert R. Franklin: Yeah, 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.

Speaker Change: Yeah, Andrew, we're, we're aware of our ability to retain capital. It's something that, since the merger happened,

Andrew: 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.

Andrew: We're certainly aware of the various ways we can do that.

Robert R. Franklin: The biggest thing that we would like to do with our capital is to grow the 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. But there's other things that we think we might be able to use this capital for, and as we make those considerations through the end of the year, I think it'll become apparent as to what our thoughts are around capital, but this isn't this isn't a time to be capital constrained. I think this is a time to have a little extra around, and so we'll see as we move through the rest of the year.

Andrew: The biggest thing that we would.

Andrew: We would like to do with our capital is to grow the franchise and to help us supplement whatever we choose as far as

Andrew: expanding our franchise. However, we are aware that that that folks would like to us to consider

Andrew: buybacks and dividends, etc. But there's other things that we think we might be able to use this capital for, and as we make those considerations through the end of the year.

Andrew: I think it'll 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.

Andrew: around and so we'll we'll see as we as we move through the rest of the year.

Andrew: Great, thank you guys, and congrats on the quarter.

Speaker Change: Great, thank you guys and congrats on the quarter.

Operator: Our next question comes from the line of John Rodis with Janney. Your line is open.

Andrew: Thanks.

Andrew: Our next question comes from the line of John Rodis with JANI. Your line is open.

John Lawrence Rodis: Good morning, guys. Hey, Paul, just a question for you just to follow up on your comments on net interest income bottoming. I assume you're talking about core net interest income, excluding yield accretion. Is that correct? Absolutely. 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?

Speaker Change: Good morning, guys.

John Lawrence Rodis: Hey, Paul, 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: Absolutely, yes.

Speaker Change: 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?

John Lawrence Rodis: You know, I'd probably look at the first quarter run rate more than the second quarter run rate, although we did benefit from a little bit more in the second quarter. And we're pleased that in the second quarter, we got a lot of payoffs and loans that we did not mind seeing paid off. And the net result is, obviously, an increase in that waterfall portion of accretion. So it's really hard to We've had quite a bit of feedback on the behavior of loans, particularly we've been pleased that some pretty low-rate loans are paying off due to the sale of property and whatnot, more so than we would have expected.

Speaker Change: You know, I'd probably look at the first quarter run rate more than the second quarter run rate. We did benefit from a

Speaker Change: a little bit more in the second quarter.

Speaker Change: and we're pleased actually in the second quarter we have got a lot of payoffs in months that we did not mind seeing payoffs and the net result is obviously

Speaker Change: and increasing that waterfall portion of accretion. So it's really hard to

Speaker Change: 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

Paul P. Egge: I'd probably guide towards conservatism closer to the first quarter versus the second quarter. But the good news is we have, you know, $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. And we see a high level of certainty in that accretion income in the coming quarters.

Speaker Change: I'd probably guide towards conservatism closer to the first quarter versus the second quarter, but the good news is we have

Speaker Change: $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. And we see a high level of certainty in that accretion income in the coming quarters.

John Lawrence Rodis: Okay, thanks, Paul. And then 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 something a little bit higher?

Speaker Change: Okay, thanks Paul. And then 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 P. Egge: I would guide you to between 20 and 21.

Paul P. Egge: I would guide you to do so.

Speaker Change: I would guide you to between 20 and 21.

Speaker Change: Okay.

Speaker Change: Thanks, guys.

Robert R. Franklin: I now turn the call back over to Bob Franklin for his closing remarks. Thank you.

Speaker Change: Thank y'all.

Speaker Change: I now turn the call back over to Bob Franklin for closing remarks.

Robert R. Franklin: Thank you. We thank all 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.

Robert R. Franklin: 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 us. You may now disconnect.

Speaker Change: Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.