Five Star Bancorp (NASDAQ:FSBC) Q4 2023 Earnings Call Transcript

Five Star Bancorp (NASDAQ:FSBC) Q4 2023 Earnings Call Transcript January 30, 2024

Five Star Bancorp isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to the Five Star Bancorp Fourth Quarter and Year-End 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 meaning 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 31st, 2022, and quarterly report on Form 10-Q for the quarter ended September 30th, 2023, and in particular, the information set forth in Item 1A, Risk Factors, in those reports. Please refer to slide two 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 figures are included in the appendix to the presentation.

Please note, this event is being recorded. I would now like to turn the conference 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 fourth quarter and the year ended December 31, 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 at fivestarbank.com and click on the Investor Relations tab. During the three months ended December 31st, 2023, our return on average assets and return on average equity were 1.26% and 15.45%, respectively, positioning us to remain near the top of our peer group. During the year ended December 31st, 2023, our return on average assets and return on average equity were 1.44% and 17.85%, respectively.

Our organic growth story continued during 2023 with the addition of 10 seasoned professionals to support our expansion into the San Francisco Bay Area market. We also continued to add new deposit accounts and relationships as seen in the growth of non-broker deposits of $269.8 million during the year ended December 31st, 2023. Despite expected headwinds on the horizon, our ability to conservatively underwrite and manage expenses with our 44% efficiency ratio and deliver value to our shareholders with our $0.20 per share dividend continue. We believe we are well positioned to continue to endure and succeed as conditions change. The fourth 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 and total assets have consistently grown since prior periods, while deposits have decreased slightly. Our pipeline continues to remain solid at the end of 2023 within verticals we have historically operated in. As presented in the portfolio diversification slide, loans held for investment increased during the quarter by $71.8 million or 2.39% from the prior quarter and increased by $290.4 million or 10.40% year-over-year, primarily within the commercial real estate concentration of the loan portfolio. Loan originations during the quarter were approximately $144.1 million and payoffs were $72.3 million. During 2023, loan originations were approximately $668.2 million and payoffs were $377.8 million. Asset quality continues to remain strong.

Though nonperforming loans have increased over the last several quarters as a result of financial challenges experienced by a small subset of our borrowers, they represent only 0.06% of the portfolio. As of December 31st, 2023, the allowance for credit losses totaled $34.4 million. We recorded a $0.8 million provision for credit losses during the fourth quarter, primarily related to loan growth, for a total provision for credit losses of $4 million for the year ended December 31st, 2023. The ratio of the allowance for credit losses to total loans held for investment was 1.12% at year-end. Loans designated as substandard totaled approximately $2 million at the end of 2023, representing an increase of approximately $1.5 million from the previous year-end, while remaining consistent with the prior quarter.

During the fourth quarter, deposits decreased slightly by $5.3 million or 0.18% as compared to the previous quarter. During 2023, deposits increased by $244.9 million or 8.8% since the end of 2022. $208.8 million of this increase related to money market accounts. Noninterest-bearing deposits as a percent of total deposits, at the end of the fourth quarter, remained stable at 27.5% as compared to the end of the previous quarter, and decreased from 34.9% at the end of the previous year. We’ll offer more detail on our deposit composition. I want to highlight that deposit relationships totaling at least $5 million constitute approximately 62% of our total deposits, and the average age on these accounts was approximately nine years. Local agency depositors accounted for approximately 27% of our deposits as of December 31st, 2023.

As noted earlier, we are pleased that we’ve had net deposit inflows for the year ended December 31st, 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 decreased slightly when compared to the prior quarter. Noninterest-bearing deposits decreased by $2.3 million, while interest-bearing deposits decreased by $3.0 million quarter-over-quarter. Cost of total deposits was 239 basis points during the fourth quarter and 197 basis points during 2023 overall. We continue to be well-capitalized, with all capital ratios well above regulatory thresholds for the quarter and the year.

Our common equity Tier 1 ratio remained constant at 9.07% between September 30th, 2023, and December 31st, 2023. On Friday, January 19th, we announced a declaration by our Board of a cash dividend of $0.20 per share on the company’s voting common stock, expected to be paid on February 12th, 2024 to shareholders of record as of February 5th, 2024. 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 $10.8 million. Return on average assets was 1.26%. And return on average equity was 15.45%. Net income for the year was $47.7 million. Return on average assets was 1.44%. And return on average equity was 17.85%. Average loan yield for the quarter was 5.64%, representing an increase of seven basis points over the prior quarter. Average yield on loans for 2023 was 5.52%, representing an increase of 77 basis points over 2022. Our net interest margin was 3.19% for the quarter, while net interest margin for the prior quarter was 3.31%. Our net interest margin was 3.42% for the year, while net interest margin for the prior year was 3.75%. Fed rate increases in 2023 continued to put pressure on deposit costs.

As a result of changes in interest rates and other factors, our other comprehensive income was $4.2 million as unrealized losses, net of tax effect, decreased on available-for-sale debt securities from $15.9 million as of September 30th, 2023, to $11.8 million as of December 31st, 2023. Noninterest income increased to $1.9 million in the fourth quarter from $1.4 million in the previous quarter, due primarily to gains from distributions on investments and venture-backed funds and the recognition of swap referral fees during the quarter. Noninterest income increased to $7.5 million in 2023 from $7.2 million in 2022, due primarily to gains from distributions on investments in venture-backed funds during the year. Noninterest expense increased to $12.7 million in the fourth quarter from $12 million in the previous quarter, primarily due to increased salaries, employee benefits, advertising, promotional and other operating expenses related to the company’s expansion into the San Francisco Bay area.

Noninterest expense increased from $40.7 million in 2022 to $47.8 million in 2023, driven primarily by a $1.2 million increase in salaries and employee benefits related to the expansion into the Bay, a $2.7 million decline in loan origination costs, a $0.7 million increase in FDIC insurance assessments, and an overall increase in expenses incurred to support a larger customer base as the leading drivers of this increase. Now that we’ve discussed the overall results of operations, I’ll 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 fourth quarter and year-end 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 have earned the trust of those we serve, including our shareholders. Looking to 2024, 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. That concludes today’s presentation. Now Heather and I will be happy to take any questions that you might have.

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question today comes from Woody Lay with KBW. Please go ahead.

Woody Lay: Hey, good morning, guys.

James Beckwith: Hey, Woody.

Heather Luck: Hi, Woody.

Woody Lay: Wanted to just start out on the margin. I was wondering if you had any expectations for the outlook over the next couple of quarters, just assuming that if rates stayed stable from here.

James Beckwith: Sure. We do have expectations. So we think that Q1 will probably be the bottom of our margin, if you were going to graph this out. So we’re expecting our margin to be anywhere between 3.15% and 3.20% for the quarter. And if rates don’t change, Woody, I think we might see an increase in our margin as we continue to execute in our growth strategy and grow more core deposits. But I think that’s kind of what we’re thinking right now. And we’ll see how the first quarter ends up. Having said that, if we’ve got any movement, which I think certainly the market expects to have some rate cuts this year, the timing is still up in the air a little bit when the first one is going to occur. But if that happens, and we are slightly liability sensitive.

So we expect a decent benefit to happen with the Fed moving in. And we will be aggressive on moving rates down. I think sometimes it happens in the industry, is that banks are not aggressive and mindful when in a declining rate environment. We do not expect to be that way.

Woody Lay: Got it. That’s super helpful color. Maybe shifting over to loan growth. It was another steady quarter of growth. As we look into 2024 and you look at your pipeline, does it feel like the high single-digit range is still the right target for you all?

James Beckwith: Yes, we’re expecting an 8% loan growth and a 10% deposit growth as we move into 2024, which has kind of been our mantra for the last four quarters, right? And I think we achieved — loan growth was probably a little higher than 8%. I think we went for over 10% and deposit growth was about 9% in 2023. So we’d like to see a 10% deposit growth and an 8% loan growth. And we think we’re fully capable and fully able of doing that given our business development activities.

Woody Lay: Yes. And would you expect the manufactured home community segment would drive a majority of that growth?

James Beckwith: I would expect they’ll continue to do what they’ve done in the past, in 2023. So I would probably think anywhere between 30% to 40% of our loan growth is going to come from that space — from that particular vertical, which, by the way, we include RV in that, RV parks, and also storage. But that’s what we’re thinking.

Woody Lay: Got it. All right. That’s all for me. Thanks for taking my questions.

James Beckwith: Thanks, Woody.

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: Hi, Andrew

Andrew Terrell: Maybe if I could start on the deposit base. I mean, it was really good to see the kind of, I’d call them, flat noninterest-bearing deposits this quarter. And I know it sounds like a lot of California banks faced some headwinds on the NIBs from tax payments this quarter. So on a relative basis, the strength is impressive. I’m just curious if you could quantify maybe the seasonal or tax-related headwind that you guys faced during the fourth quarter. Just trying to get a sense of like the underlying kind of new growth that you saw that was able to offset potentially that headwind.

James Beckwith: Yes. There was a couple of factors that happened, especially in the last part of December, frankly. A lot of bonus payments and a lot of our professional service firms were bonusing out their top employees. So we saw some decline in some balances from that. And also, in California, most of the counties were on the deferral given the atmospheric rain that we had in January, we were declared, I guess, a Disaster County, I know Sacramento was. And so that allowed a lot of the counties and the businesses that reside in those counties and the individuals to not have to make their final payments until October 15. So that did have an impact. That was offset by, I think, some pretty strong activity that we saw from our San Francisco folks, and then also other activity that we saw in our operations out here in the capital region. So net-net, when you all roll that all together were ever so slight decline. And I think it was a lot of effort to get to that, too.

Andrew Terrell: Yes. Okay. I appreciate it. Heather, do you have the spot costs on either the interest-bearing or the total deposits as of 12/31?

Heather Luck: Yes. So total — the spot rate was 2.48 at year-end.

Andrew Terrell: Okay. Thank you for that. And then, James, if I could get maybe your thoughts on, you’ve done a really impressive job on the new hire front, particularly in the back half of 2023. I know it’s been your mantra for a long time here. Just as you look into 2024, do you see any incremental talent additions on the horizon? And I know there was a deal may be announced in your neck of the woods earlier today. Any opportunities you see coming out of that?

James Beckwith: Well, we certainly know the folks from California Bank of Commerce that operate within the capital region pretty well, actually. Most of them kind of came out of the Wells Fargo operations here. Some good small to medium-sized professionals. I mean, they focus on that C&I. There’s some good talent there. Time will tell. I haven’t talked to any of them yet. So — but plan to do so. Yes. We continue to be opportunistic. I mean, there is some talent there. But there’s also talent down in the Bay Area, too, that we’re continued excited about in terms of growing out what we’re doing down there. So I would expect some additional business development hires to happen in the first half of the year of 2024. I mean we are planning on that. So to answer your question, we’re going to bring some more firepower to bear in the markets we serve.