Five Star Bancorp (NASDAQ:FSBC) Q3 2023 Earnings Call Transcript

Five Star Bancorp (NASDAQ:FSBC) Q3 2023 Earnings Call Transcript October 31, 2023

Operator: Welcome to the Five Star Bancorp Third Quarter Earnings Webcast. Please note, this is a closed conference call, and you are encouraged to listen via the webcast. After today’s presentation, there will be an opportunity for those provided with a dial-in number to ask questions. [Operator Instructions]. Before we get started, let me remind you that today’s meeting will include some forward-looking statements within the meanings of applicable securities laws. These forward-looking statements relate to, among other things, current plans, expectations, events and industry trends that may affect the company’s future operating results and financial position. Such statements involve risks and uncertainties and future activities and results may differ materially from these expectations.

For a more complete discussion of the risks and uncertainties that may cause actual results to differ materially from the company’s forward-looking statements. Please see the company’s Annual Report on Form 10-K for the year ended December 31, 2022, and Quarterly Report on Form 10-Q for the quarter ended June 30, 2023, and in particular, the information set forth in Item 1A, Risk Factors in those reports. Please refer to Slide 2 of the presentation, which includes disclaimers regarding forward-looking statements, industry data and non-GAAP financial information included in this presentation. Reconciliations of non-GAAP financial measures to their most directly comparable GAAP measures are included in the appendix to the presentation. Please note this event is being recorded.

I would now like to turn the presentation over to James Beckwith Five Star Bancorp, President and CEO. Please go ahead.

James Beckwith: Thank you for joining us to review Five Star Bancorp’s financial results for the third quarter of 2023. Joining me today is Heather Luck, Senior Vice President and Chief Financial Officer. Our comments today will refer to the financial information that was included in the earnings announcement released yesterday. To obtain a copy of the release, please visit our website fivestarbank.com and click on the Investor Relations tab. During the three months ended September 30, 2023, our return on average assets and return on average equity were 1.30 and 16.09, respectively, positioning us to remain near the top of our peer group. In the third quarter, we enhanced our expansion into the Bay Area market with an addition of another seasoned team of professionals.

Our organic growth story also continued in the third quarter with the addition of new deposit accounts and relationships as seen in the growth of non-broker deposits of $137.5 million in the three months ended September 30, 2023. Despite expected headwinds on the horizon, our ability to conservatively underwrite as evidenced by a 51% LTV on commercial real estate, managed expenses with our 42% efficiency ratio and deliver value to shareholders with our $0.20 per share dividend. We believe we are well positioned to continue to endure and succeed as conditions change. In the company overview section, we have provided a brief overview of our geographic footprint and executive management team. In the third quarter of 2023 exhibited continued execution of our growth strategy as evidenced by our earnings, expense management, and balance sheet trends during the quarter.

Additionally, loans, deposits, and total assets have consistently grown since the prior periods. Our pipeline continues to remain solid at the end of the third quarter of 2023 within verticals we have historically operated in, as presented in the loan portfolio diversification slide. Loans held for investment increased during the quarter by $82.5 million or 2.82% from the prior quarter, primarily within the commercial real estate concentration of the portfolio. Loan originations during the quarter were approximately $134.6 million, while payoffs and paydowns were $52.1 million. Asset quality continues to remain strong. Though nonperforming assets have increased from the last several quarters as a result of financial challenges experienced by a small subset of our borrowers.

They represent 0.07% of the portfolio. At the end of the third quarter, the allowance for credit losses totaled $34.0 million, we recorded a $1.1 million provision for credit losses during the quarter, primarily related to loan growth, loan type mix and updates to the macro environment. The ratio of the allowance for credit losses to total loans held for investment was 1.13% at quarter end. Loans designated as substandard totaled approximately $2.0 million at the end of the quarter, which was an increase from $0.3 million at the end of the previous quarter. Now that we have discussed the loan portfolio, we will continue on to deposits and capital. During the third quarter, deposits increased $102.5 million or 3.5% as compared to the previous quarter.

Noninterest-bearing deposits as a percent of total deposits at the end of the third quarter decreased slightly to $27.5 million from 28.4% at the end of the previous quarter. To offer more detail on our deposit composition, I want to highlight that deposit relationships totaling at least $5 million constituted approximately 60% of our total deposits, and the average age on these accounts was approximately nine years. Local agency depositors accounted for approximately 25% of deposits as of September 30, 2023. As noted earlier, we are pleased we have net deposit inflows for the three months ended September 30, 2023. Our ability to grow deposit accounts supports our differentiated customer-centric model that our customers trust and value. As seen through the mix of high dollar accounts and the duration of certain customer relationships, we believe we have a reliable core deposit base.

Overall, deposit balances have increased when compared to the prior quarter. non-broker deposits increased by $137.5 million, interest-bearing deposits increased by $101.7 million and noninterest-bearing deposits increased by $0.8 million. Total cost of deposits was 218 basis points during the third quarter. We continue to be well capitalized with all capital ratios well above regulatory thresholds for the quarter. Our common equity Tier 1 ratio increased from 9.05% to 9.07% between June 30, 2023, and September 30, 2023. On Friday, October 20, we announced a declaration by our Board a cash dividend of $0.20 per share on the company’s voting common stock expected to be paid on November 13, 2023, to shareholders of record as of November 6, 2023.

On that note, I will hand it over to Heather to discuss the results of operations. Heather?

Heather Luck: Thank you, James, and hello, everyone. Net income for the quarter was $11 million. Return on average assets was 1.3% and return on average equity was 16.09%. Average loan yield for the quarter was 5.57%, representing an increase of 7 basis points over the prior quarter as rate increases continued with fourth increase this year taking place in July. Our net interest margin was 3.31% for the quarter, while net interest margin for the prior quarter was 3.45%. The most recent Fed rate increase continues to put pressure on deposit costs. As a result of changes in interest rates and other factors, our other comprehensive loss was $3 million during the three months ended September 30, 2023, as unrealized losses, net of tax effect, increased on available-for-sale debt securities from $12.9 million as of June 30, to $15.9 million as of September 30, 2023.

Noninterest income decreased to $1.4 million in the third quarter from $2.8 million in the previous quarter, due primarily to a $1.3 million gain in other income recognized on distributions received on investments and venture-backed funds during the three months ended June 30. Noninterest expense grew by $36,000 in the three months ended September 30th as compared to the three months ended June 30th, primarily due to a $0.5 million increase in salaries and employee benefits, which was partially offset by decreases of $0.3 million and $0.2 million in other operating and advertising and promotional expenses. Now that we’ve discussed the overall results of operations, I will now hand it back to James to provide some closing remarks.

James Beckwith: Thank you, Heather. I want to thank everyone for joining us as we discuss third quarter results. Five Star Bank has a reputation built on trust, speed to serve, and certainty of execution which supports our clients’ success. Our financial performance is the result of a truly differentiated customer experience, which continues to power the demand for Five Star Bank’s relationship-based services. We attribute sustained success to our prudent business model and treating customers with an empathetic spirit, understanding and care, we are very proud to earn the trust of those we serve, including our shareholders. In the third quarter, our efforts were recognized as we were listed among Piper Sandler’s Sm-All Stars for 2023 as a top performing small-cap bank, acknowledge for outperformance in several metrics, including growth, profitability, asset quality and capital.

We were also listed among Sacramento Business Journal’s Best Places to Work. Looking to the remainder of 2023, we will be guided by a continued focus on shareholder value as we monitor market conditions. We are confident in the company’s resilience in any environment and remain focused on the future and our long-term strategy. We will continue to execute our organic growth and disciplined business practices, which we believe will benefit our customers, employees community and shareholders. We appreciate your time today. This concludes today’s presenting. Now Heather and I will be happy to take any questions you may have.

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions]. The first question today comes from Gary Tenner with D.A. Davidson. Please go ahead.

Gary Tenner: Thanks. Good morning. Wanted to ask about the loan growth this quarter. The commercial real estate growth looked pretty concentrated between manufactured home community, RV park and multifamily. So just wondering what you could tell us about kind of the ongoing demand, particularly in those loan areas. And maybe what the new loans coming on board right now, what they look like from a kind of debt service coverage, LTV, any kind of underlying metrics around the new loan production there?

James Beckwith: Sure. Well, Gary, things have slowed. We expect to see that in the fourth quarter and probably well into the first quarter, given where cap rates are and interest rates are generally speaking. In our underwriting for all of our loan portfolio, new originations. It’s been very consistent over the years, and we haven’t changed anything. We do have higher standards for out-of-state credit than in-state credit. So it’s been very consistent. We continue to focus on manufactured home communities and RV parks [ph], and we expect to see same or similar in the fourth quarter. But we are starting to grow our C&I book. So we’re hopefully — that can be attractive business proposition for our prospects to come bank with us.

We do have a pretty significant effort going on, Gary, right now down in the Bay Area, but also up here in the Sacramento in the capital region, if you will. So nothing’s really changed from an underwriting perspective. I think you can see in the deck what our LTVs are, and we’re very much cash flow lenders. So we always like to have a very nice cash flow. I think $135 million is at origination in terms of our mobile home park book of business, but we’ve been very consistent over the years.

Gary Tenner: Great, James. I appreciate that. And then a second question, I don’t know that I saw it in the deck, so I apologize if I missed it, but the deposit spot rate as of September 30, Heather, if you could provide that for us either interest-bearing or total deposits?

Heather Luck: Yes. Total spot rate was 224.

Gary Tenner: Okay. The average was 218. So was there a kind of notable slowdown in the pace of change over the course of the third quarter?

James Beckwith: Yes, very much so. There’s still pressure, but I think that the pace of change has slowed. We’re very — a lot of our customers, given that we have such a big book in our local agency are very rate sensitive. And so it’s really depending upon what the Fed does, we could see some reaction there. But the pace of change has slowed.

Gary Tenner: Thanks very much.

Operator: The next question comes from Andrew Terrell with Stephens. Please go ahead.

Andrew Terrell: Hey, good morning.

James Beckwith: Hey, good morning, Andrew.

Heather Luck: Good morning.

Andrew Terrell: I wanted to ask about some of the recent expansion of the Bay Area. It looked like the teams there or the team there did $29 million of deposits in the third quarter, so obviously kind of hitting the ground running. I was just curious, are those mostly non-interest-bearing deposits? I know there’s a more C&I oriented focus there. So were they mostly NIBs or was it across the board? And then separately, just anything on the loan production side from those teams this quarter and just how the pipeline is shaping up there for both deposits and for loans?

James Beckwith: Sure. Right now, as we sit here today, I think we’ve got about $38 million in deposits from our Bay Area folks, San Francisco folks. I think that that’s equally split between non-interest-bearing and interest-bearing. And the reason for that is the typical account that we’re picking up right now. We’re getting their operating account, Andrew, but we’re also getting their liquidity. So when you kind of mush those together, we’re looking anywhere depending upon the relationship of those balances anywhere between 2% to 2.5% all in. So we expect that to be same or similar. From a lending perspective, I think we’ve got $5 million of credit book so far. A lot of it is C&I. There’s some CRE, the most of it of it is lines of credit.