KBRA Affirms Ratings for Stellar Bancorp, Inc.

KBRA affirms the senior unsecured debt rating of BBB, the subordinated debt rating of BBB-, and the short-term debt rating of K3 for Houston, Texas based Stellar Bancorp, Inc. (NYSE: STEL). In addition, KBRA affirms the deposit and senior unsecured debt ratings of BBB+, the subordinated debt rating of BBB, and the short-term deposit and debt ratings of K2 for the lead subsidiary, Stellar Bank. The Outlook for all long-term ratings is Stable.

Key Credit Considerations

The ratings are supported by solid earnings performance with core ROA of ~1.40% in 9M23 tracking well above the peer average. Earnings are driven by NIM that has historically tracked higher than peers, reinforced by higher loan yields derived from an underserved and smaller-scaled commercial customer base, comparatively elevated C&D lending, and acceleration in purchase accounting accretion income due to payoffs that have exceeded management's expectations. Additionally, the immense value of the robust and durable NIB deposit mix (42% of deposits at 3Q23) has been instrumental in sustaining total deposit costs (1.70% in 3Q23) that continue to track lower than the KBRA peer average. With that said, earnings are spread-reliant, which creates additional headwinds in prolonged high rate or low-growth economic environments. The ratings are also underpinned by a highly capable management team with deep-rooted ties to economically attractive Texas markets of Houston, southeast Texas, and to a lesser extent, Dallas-Fort Worth. While we acknowledge that the credit environment had been benign for an extended period, we attribute the historically solid and stable credit and earnings performance of pre-merger Allegiance Bancshares, Inc. and CBTX, Inc. (merger closed on October 1, 2022) to management teams that continue to lead the contemporary franchise. In common with many peers, the effects of the Fed rate hikes have induced a meaningful shift in the deposit composition since YE22, which has led to a higher mix of maturity deposits (17% of deposits at 3Q23) and NIB deposit outflow. With that said, we consider the core funding profile as moderately improved relative to legacy Allegiance measures, bolstered by CBTX’s historically lower-cost, lower beta, and largely deposit-centric funding mix. Despite modestly higher levels of charge-offs in 3Q23 and in 4Q22, which we viewed as isolated and partly attributable to post-merger maintenance, overall asset quality is manageable. Criticized assets only accounted for ~2% of loans at 3Q23 while non-owner occupied office exposures were minimal, at ~3% of total loans. Disciplined balance sheet management, strong earnings, a low dividend yield, and a pause in stock buybacks have resulted in impressive capital accretion since YE22, with the CET1 ratio (11.1% at 3Q23) increasing by 110 bps. While regulatory capital levels are sufficient, we view it as necessary to maintain capital ratios at peer-like or higher levels given the C&D concentration, comparatively higher RWA density, and some exposure to oil and gas (~5% of loans), the latter of which mostly support midstream activities.

Rating Sensitivities

A rating upgrade is not expected over the medium term. However, demonstrating above average earnings performance with substantial growth in fee income, particularly from verticals less correlated to lending, while consistently managing capital ratios above the peer average could lead to positive rating momentum over time. Conversely, meaningful regression in asset quality, persistently low capital ratios in relation to rated peers, or unforeseen deterioration in the funding profile could pressure the ratings.

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