Executive Summary / Key Takeaways

• Strategic Transformation and Core Focus: Stellar Bancorp (NYSE:STEL) has strategically transformed from a collection of smaller community banks into a scaled regional player following its 2022 merger, emphasizing relationship-driven commercial banking for small-to-medium sized businesses in dynamic Texas markets. This shift includes a deliberate rebalancing of its loan portfolio towards stickier Commercial & Industrial (C&I) credits and a strong focus on low-cost, core deposit growth.
• Robust Financial Health and Margin Defense: The company reported solid Q3 2025 results with net interest income increasing to $100.6 million and a net interest margin (NIM) of 4.2%, with the core NIM (excluding purchase accounting accretion) reaching 4.00%. Stellar Bancorp maintains a strong capital position, with total risk-based capital at 16.33% and tangible book value per share growing 9.3% year-over-year to $21.08, providing significant financial flexibility.
• Disciplined Growth Amidst Competition: Stellar Bancorp is pivoting to organic growth in 2025, targeting mid-single-digit loan expansion, particularly in the latter half of the year, driven by increasing originations and strategic talent acquisition. Despite intense competition and M&A disruption in Texas, the company prioritizes full client relationships and disciplined underwriting over aggressive pricing.
• Prudent Credit Management: While experiencing some charge-offs in Q3 2025, these were spread across small credits and largely pre-reserved, reflecting management's conservative approach. The allowance for credit losses on loans stood at 1.1% of total loans, and nonperforming assets were 0.51% of total assets, with management expressing comfort in current reserve levels.
• Outlook for Operating Leverage: Management anticipates modest noninterest expense growth of approximately $295 million for 2025, in line with inflation, and expects to achieve positive operating leverage by outpacing expense growth with revenue expansion, leveraging its scalable platform and an improving operating environment.

Forging a Core Banking Powerhouse in Texas

Stellar Bancorp, Inc. (NYSE:STEL), founded in 2007 and headquartered in Houston, Texas, has strategically positioned itself as a relationship-driven commercial bank serving small-to-medium sized businesses, professionals, and individuals across the vibrant Houston, Beaumont, and Dallas metropolitan statistical areas. The company's journey took a pivotal turn with its 2022 merger, which propelled it past the $10 billion asset threshold, necessitating a comprehensive re-evaluation of its operational framework and loan portfolio. This transformation has seen Stellar Bancorp deliberately reconfigure its balance sheet, moving away from a sole reliance on smaller real estate loans to a more diversified approach with an increased emphasis on Commercial & Industrial (C&I) credits.

The company's overarching strategy is clear: to expand its relationship-generated, low-cost core funding base while broadening its loan offerings. This approach is designed to build Stellar into the bank of choice in its markets, leveraging its deep roots in Texas and a commitment to personalized banking services. Stellar Bancorp's operational footprint includes 54 banking centers, with a significant concentration in the Houston MSA, underscoring its localized expertise.

Competitive Dynamics in a Dynamic Market

Stellar Bancorp operates within a highly competitive Texas banking landscape, characterized by the presence of both large national players and agile regional institutions. Competitors such as Prosperity Bancshares (PB), Independent Bank Group (IBTX), Comerica (CMA), and Regions Financial (RF) vie for market share. Stellar Bancorp differentiates itself through its localized, customer-focused approach, which fosters strong client relationships and loyalty. This strategy allows Stellar to make incremental inroads against larger institutions, particularly in the Houston market where, as CEO Robert Franklin noted, a single large competitor holds a substantial market share. Stellar's emphasis on personalized service and regional expertise provides an edge in operational execution, countering the broader scale of some rivals.

However, Stellar Bancorp faces challenges related to its more limited geographic scale compared to larger competitors, which could restrict revenue diversification and increase susceptibility to local economic shifts. While the company leverages standard banking technology to enhance its relationship-driven model, it does not highlight proprietary technological differentiators in the same vein as some fintech-focused rivals. Instead, its competitive advantage in this area stems from effective deployment of existing digital tools (e.g., mobile and online banking) to support its core relationship strategy. The ongoing M&A disruption in Texas, driven by the state's business-friendly environment, presents both opportunities for customer and talent acquisition and challenges from new players offering aggressive pricing or "credit light" covenant packages, which Stellar Bancorp has indicated it will not pursue.

Financial Performance and Operational Strength

Stellar Bancorp delivered solid financial results for the third quarter of 2025. Net income was $25.7 million, or $0.50 per diluted share, compared to $26.4 million, or $0.51 per diluted share, in the second quarter of 2025. This modest decrease was primarily attributed to a $6.3 million increase in the provision for credit losses, a $1.3 million decrease in noninterest income, and a $2.1 million increase in noninterest expense, partially offset by a $2.3 million decrease in the provision for income taxes. The annualized return on average assets (ROAA) for Q3 2025 was 0.97%, and the annualized return on average tangible common equity (ROATCE) stood at 11.45%.

Net interest income (NII) for the third quarter of 2025 increased to $100.6 million from $98.3 million in the prior quarter, driven by higher earning assets and an improved net interest margin (NIM). The reported NIM for Q3 2025 was 4.2%, up from 4.18% in Q2 2025. Notably, excluding purchase accounting accretion, the tax-equivalent NIM reached 4.00% in Q3 2025, a significant achievement that management is "really proud" of. Interest income for the three and nine months ended September 30, 2025, saw a decrease primarily due to lower average loans and loan yields, though this was partially offset by an increase in average securities and their yields. The yield on the securities portfolio increased to 3.79% for the three months and 3.77% for the nine months ended September 30, 2025. Interest expense decreased due to lower interest rates and a reduction in higher-rate certificates and time deposits, with the cost of average interest-bearing liabilities falling to 3.15% for both periods.
Noninterest income for Q3 2025 totaled $5 million, a decrease from $6.3 million in the same period of 2024, mainly due to $445,000 in write-downs on foreclosed assets and lower other noninterest income, partially offset by Federal Reserve Bank (FRB) dividends. Noninterest expense increased to $73.1 million in Q3 2025 from $70 million in Q2 2025. This rise was primarily due to a $2.1 million increase in salaries and employee benefits, including approximately $0.5 million in severance expense related to planned branch closures, as well as elevated medical insurance expenses, professional fees, and advertising. The efficiency ratio, a key metric for operational effectiveness, increased to 63.69% for the three months and 62.50% for the nine months ended September 30, 2025, reflecting a higher resource utilization to generate income.

The loan portfolio at September 30, 2025, stood at $7.17 billion, a 3.70% decrease from December 31, 2024. Commercial real estate and commercial construction loans constituted 62.60% of total loans, a slight reduction from 63.40% at year-end 2024, aligning with the company's strategy to diversify. Loan originations in Q3 2025 were nearly $500 million, contributing to a 62% year-to-date increase in originations compared to the prior year, with a healthy mix including C&I loans. Payoffs, however, remained elevated at $330 million in Q3 2025, with approximately 44% linked to collateral/business sales and 25% to competitive refinances. Total deposits increased by $143.8 million to $8.82 billion at September 30, 2025, driven by growth in money market and savings deposits. Notably, 51% of new deposits onboarded in Q3 2025 came from new customers, underscoring the success of Stellar Bancorp's relationship-driven deposit strategy.

Credit Quality and Risk Management

Stellar Bancorp maintains a conservative approach to credit risk management. The provision for credit losses in Q3 2025 was $305,000, primarily driven by an increase in the allowance for unfunded commitments. Net charge-offs for the quarter totaled $3.3 million, spread across multiple small credits, most of which were already identified and specifically reserved for, thus mitigating their impact on the quarterly provision. Year-to-date net charge-offs were approximately 7 basis points annualized. The allowance for credit losses on loans was $78.9 million, or 1.1% of total loans, at September 30, 2025. Nonperforming assets totaled $54.2 million, or 0.51% of total assets, at the end of Q3 2025.

Management expressed comfort with the current reserve levels, emphasizing that credit trends remain favorable in its stable Texas markets. The company has limited exposure to non-originated credits and only three shared national credits, all with established business ties. Stellar Bancorp's credit philosophy centers on rigorous underwriting and ongoing monitoring, with a strong focus on primary sources of cash flow and secondary repayment sources. While acknowledging the inherent uncertainty in economic conditions and the potential impact of factors like new tariff policies, the company adopts a cautious "wait and see" attitude, noting no significant deterioration in customer financial reports to date.

Strategic Outlook and Capital Deployment

Stellar Bancorp is poised for a period of focused growth and operational optimization. Management anticipates noninterest expenses for Q4 2025 to normalize closer to the run rate of the first half of the year, rather than the elevated Q3 levels, which included one-time severance costs. For the full year 2025, noninterest expense is projected to see modest growth, aligning with inflation, to approximately $295 million. The company's goal is to achieve positive operating leverage by ensuring revenue growth outpaces expense dynamics, capitalizing on its scalable platform.

The outlook for the net interest margin remains positive, with management aiming to defend and incrementally improve its core NIM, potentially reaching a "4 handle" excluding purchase accounting accretion. Paul Egge, CFO, noted that potential Fed rate cuts could benefit the margin in the medium term due to the normalization of the yield curve. Stellar Bancorp targets mid-single-digit loan growth for 2025, with an expectation for growth to be more pronounced in the latter half of the year as originations continue to increase and offset initial payoffs. Deposit growth remains a key strategic priority, driven by expanding existing relationships and acquiring new customers through its disciplined, relationship-focused model.

Capital deployment is a central theme for Stellar Bancorp. Organic growth is the primary use of capital, reflecting the company's commitment to expanding its core banking business. However, its strong capital position, with total risk-based capital at 16.33%, provides significant flexibility for other strategic initiatives. The company recently redeemed $30 million of its subordinated debt and continues to evaluate further debt redemptions and share repurchases. While M&A remains an option to accelerate operating leverage, management is highly disciplined, prioritizing strategic alignment and protection of its strong balance sheet and funding base over mere size. The company's dual listing on NYSE Texas also underscores its commitment to the state and its strategic positioning within the regional financial ecosystem.

Conclusion

Stellar Bancorp, Inc. stands at a compelling juncture, having successfully navigated a significant merger and strategically rebalanced its operations to emerge as a formidable regional banking presence in Texas. The company's core investment thesis is rooted in its disciplined, relationship-driven commercial banking model, which consistently delivers strong core net interest margins and robust internal capital generation. Stellar Bancorp's strategic pivot towards organic growth, coupled with its prudent credit management and a clear focus on low-cost deposit acquisition, positions it favorably within the dynamic and competitive Texas market.

While the banking sector faces ongoing economic uncertainties and competitive pressures, Stellar Bancorp's fortress-like balance sheet, flexible capital allocation strategy, and commitment to operational efficiency provide a solid foundation. The company's ability to attract new customers and talent amidst market disruption, combined with its strategic intent to achieve positive operating leverage, underscores its potential for long-term shareholder value creation. Investors should recognize Stellar Bancorp's disciplined approach and its strategic positioning in a high-growth region as key drivers for its continued ascent in the regional banking landscape.