Competitive Loan Growth And Funding Pressures Will Constrain Long Term Performance

Catalysts

About Stellar Bancorp

Stellar Bancorp operates a regional banking platform focused on relationship banking, with an emphasis on loans and deposits across its Texas markets.

What are the underlying business or industry changes driving this perspective?

• The push to grow loans in a very competitive Texas market, where some new entrants are reportedly using aggressive pricing and lighter covenants, could pressure Stellar Bancorp either to accept slower loan growth or to sacrifice credit discipline. This may weigh on revenue growth or future credit costs and net margins.
• Management highlights strong low cost deposit gathering and rising brand awareness. However, intensifying competition for deposits across the banking sector may force higher funding costs over time, which could limit the benefit of the current 4% net interest margin on future earnings.
• The bank is carrying meaningful excess liquidity with an eye toward future loan growth and potential securities purchases. If payoff and paydown activity remains high relative to originations, that liquidity could earn lower yields for longer, constraining net interest income and returns on assets.
• Elevated loan originations and an expanding unfunded commitments base are expected to support funded loan balances. However, if advances continue to trail scheduled payments and payoffs, balance sheet growth could stall, which would restrict scale benefits and slow any improvement in efficiency and earnings.
• Management cites recent M&A activity in Texas as a source of opportunities. An increase in larger out of state competitors and potential future combinations could compress spreads and raise customer acquisition costs, putting pressure on revenue growth and operating leverage even with the current strong capital position.

Assumptions

This narrative explores a more pessimistic perspective on Stellar Bancorp compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Stellar Bancorp's revenue will grow by 4.1% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 24.9% today to 23.9% in 3 years time.
• The bearish analysts expect earnings to reach $111.5 million (and earnings per share of $2.4) by about February 2029, up from $102.9 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $135.3 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 15.9x on those 2029 earnings, down from 18.7x today. This future PE is greater than the current PE for the US Banks industry at 11.8x.
• The bearish analysts expect the number of shares outstanding to decline by 3.87% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.96%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The bank reports a 4.2% net interest margin, or 4% when excluding purchase accounting accretion, and management repeatedly talks about defending this "top tier" margin. If they keep holding pricing discipline on both loans and deposits, earnings could be more resilient than a bearish view assumes, supporting net interest income and overall earnings.
• Management highlights solid credit metrics with year-to-date net charge-offs of about $3.7 million, roughly 7 basis points annualized, and an allowance for credit losses on loans of $78.9 million equal to 1.1% of loans. If this conservative credit posture continues alongside what they describe as favorable credit trends, future credit costs could stay contained and support net margins and earnings.
• The call repeatedly points to strong deposit growth, a focus on low-cost deposits, rising brand awareness and improved customer satisfaction scores, and over half of new deposits in the quarter coming from new customers. If this franchise momentum continues in growing and retaining deposits, the funding base could remain a strength that supports revenue and net interest income.
• Management refers to a "very strong" capital position, with total risk-based capital of 16.33% and year-over-year tangible book value per share increasing 9.3% from $19.28 to $21.08 after dividends and share repurchases. Continued internal capital generation and buybacks could support per-share earnings and tangible book value.
• The company operates in Texas and management repeatedly cites loan origination growth, a healthy pipeline and opportunities created by M&A activity and larger out-of-state competitors. If long-term economic and population growth in its markets continues, that could support ongoing loan demand and relationship growth, which would be a positive for revenue and earnings.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Stellar Bancorp is $32.0, which represents up to two standard deviations below the consensus price target of $38.0. This valuation is based on what can be assumed as the expectations of Stellar Bancorp's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $44.0, and the most bearish reporting a price target of just $32.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $466.8 million, earnings will come to $111.5 million, and it would be trading on a PE ratio of 15.9x, assuming you use a discount rate of 7.0%.
  
• Given the current share price of $37.88, the analyst price target of $32.0 is 18.4% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.