Five Star Bancorp - Q2 2024

Transcript

Operator (participant)

Good afternoon, everyone, and welcome to the Five Star Bancorp second quarter 2024 earnings webcast. Please note that this is a closed conference call. 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. To ask a question, you may press star and one using the telephone keypad. To withdraw your questions, you may press Star and Two. 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 ending September 30th, 2023. 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 the presentation. Reconciliations of non-GAAP financial measures to their most directly comparable GAAP, GAAP figures are included in the appendix for the presentation. Please note, this event is being recorded. At this time, I'd like to turn the conference call over to James Beckwith Five Star Bancorp, President and CEO. Please go ahead.

James Beckwith (President and CEO)

Thank you for joining us to review Five Star Bancorp's financial results for the second quarter of 2024. 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. Our organic growth story continued in the second quarter with the successful close of our public offering, resulting in the issuance of 3,967,500 additional shares of common stock, with net proceeds of approximately $80.9 million, allowing us to continue our momentum in the San Francisco Bay Area.

We added five more seasoned professionals to support this expansion and also continued to add new core deposit accounts and relationships, as seen in the increase of non-wholesale deposits of $118.3 million during the three months ended June 30, 2024. Despite continued external headwinds, we maintained our ability to conservatively underwrite, as evidenced by a 50% loan-to-value on commercial real estate, manage expenses with our 44% efficiency ratio, and deliver value to our shareholders with our $0.20 per share dividend for the first and second quarters of 2024. The second quarter of 2024 exhibited continued execution of our growth strategy and efforts to position for future growth, as evidenced by our earnings, expense management, and balance sheet trends during the quarter.

Additionally, we saw a positive turn in margin compression and loans. Total assets and deposits have grown since prior periods. Our pipeline continues to remain solid at the end of the second quarter of 2024 within verticals we have historically operated in, as presented in the loan portfolio diversification slide. Loans held for investment increased during the quarter by $162.2 million, or 5.22% from the prior quarter, primarily relating to the purchase of loans with the consumer concentration of the loan portfolio, representing $73.3 million of the increase. Total originations during the quarter were approximately $390 million, while payoffs and paydowns were $72.8 million and $155 million, respectively. Asset quality continues to remain strong.

Though non-performing loans increased in the beginning of the third quarter of 2023, they continued to represent only 0.06% of the portfolio at the end of the quarter. At the end of the second quarter, the allowance for credit losses totaled $35.4 million. We reported a $2 million provision for credit losses during the quarter, with loan growth and increases in net charge-offs as the leading drivers. The allowance for credit losses to total loans held for investment was 1.08% at quarter end. Loans designated as substandard totaled approximately $1.9 million at the end of the quarter, which is unchanged from the end of the previous quarter. During the second quarter, deposits increased by $193.9 million, or 6.56%, as compared to the previous quarter.

Non-interest bearing deposits as a percent of total deposits at the end of the second quarter decreased slightly from 26.2%-26.2% from 27.7% at the end of the previous quarter. As noted earlier, we are pleased we had a net non-wholesale deposit inflows for the three months ended June 30, 2024. 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 had a reliable core deposit base. To offer more detail on our deposit composition, I want to highlight that deposit relationships totaling at least $5 million constituted approximately 60% of total deposits, and the average age of these accounts was approximately eight years.

Local agency depositors accounted for approximately 22% of deposits as of June 30, 2024. Overall, deposit balances have increased when compared to the prior quarter. Wholesale deposits, which we defined as broker deposits and public time deposits, increased by $75.5 million. Non-wholesale deposits increased by $118.3 million, driven by $110 million increase in non-wholesale interest-bearing deposits and an $8.3 million increase in non-interest bearing deposits. Cost of total deposits was 247 basis points during the second quarter, a decrease of 6 basis points from the first quarter. We continue to be well capitalized, with all capital ratios well above regulatory thresholds for the quarter. The additional common stock issued through the public offering that closed in April of 2024 is noticeable in our capital ratios for the second quarter.

Our Common Equity Tier 1 ratio increased from 9.13%-11.28% between March 31, 2024 and June 30th, 2024. On July 18, our board declared a cash dividend of $0.20 per share on the company's voting common stock, expected to be paid on August 12th, 2024, to shareholders of record as of August 5th, 2024. On that note, I will hand it over to Heather to discuss the results of operations. Heather?

Heather Luck (SVP and CFO)

Thank you, James, and hello, everyone. Net income for the quarter was $10.8 million, return on average assets was 1.23%, and return on average equity was 11.72%. Average loan yield for the quarter was 5.83%, representing an increase of 12 basis points over the prior quarter. Our net interest margin was 3.39% for the quarter, while net interest margin for the prior quarter was 3.14%, with loan growth at higher yields and decreased reliance on wholesale deposits as the primary drivers.

As a result of changes in interest rates and other factors, our other comprehensive income was $0.2 million during the three months ended June 30, 2024, as unrealized losses, net of tax effect, decreased on available-for-sale debt securities from $12.4 million as of March 31st to $12.2 million as of June 30, 2024. Non-interest income decreased to $1.6 million in the second quarter from $1.8 million in the previous quarter, due primarily to a reduction in gains from distributions received on equity investments in venture-backed funds during the three months ended June 30, 2024. This decrease was partially offset by an increase in gains on the sale of loans during the three months ended June 30.

Non-interest expense grew by $0.8 million in the three months ended June 30, compared to the three months ended March 31st, primarily due to increases in commissions related to higher loan production, travel, conferences, and professional membership fees, and sponsorships and donations during the quarter. 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 (President and CEO)

Thank you, Heather. I want to thank everyone for joining us as we discussed second quarter results. Five Star Bank has a reputation built on trust, speed to serve, and certainty of execution, which support 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. As we continue to lean into 2024, we are 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 on 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 presentation. Now, Heather and I will, will be happy to take any questions that you might have.

Operator (participant)

Once again, if you would like to ask a question, please press star and one. Our first question today comes from Andrew Terrell from Stephens. Please go ahead with your question.

Andrew Terrell (Managing Director and Research Analyst of Regional Banks)

Hey, good morning.

James Beckwith (President and CEO)

Hey, good morning, Andrew.

Andrew Terrell (Managing Director and Research Analyst of Regional Banks)

Maybe just to start off, can you talk a little bit about the consumer loan purchase in the quarter? Kind of what these loans were specifically, what kind of the yield and the credit profile looks like there. And then just more broadly, talk about the strategy behind it, particularly kind of considering the recent capital raise and what it feels like as a ramping kind of organic growth profile.

James Beckwith (President and CEO)

Sure. These loans were originated by Bankers Health Group, BHG. Their credit profile is very strong. I think I'm gonna say mid-750 FICOs. These are professional individuals throughout the United States. We've been involved with BHG for several years now, and have had a really strong credit experience with loans that we've purchased from them. We're buying them, Andrew, at an 8.25% yield. That was kind of the average yield for purchases in Q2. They've been operating like this for several years now. Very strong franchise. A lot of banks throughout the United States utilize them.

We first got into it by wanting to make sure that we had appropriate coverage for our small business loans from a CRA perspective, and that's expanded, given our very favorable credit experience with them. It's a shot in the arm. Certainly, we're not gonna rely on it in terms of, you know, overall growth of the loan portfolio, but it's additive, and it's coming on at a nice, nice margin, nice rate, nice yield, and we like the credit characteristics.

Andrew Terrell (Managing Director and Research Analyst of Regional Banks)

Yep, understood. Okay, and was the purchase made? Do you have kind of a specific timing throughout the quarter? Just trying to get a better sense. I mean, loan yields were up 12 basis points in the quarter, and they in the quarter here obviously helps that. Just trying to get a sense of whether there's some carryforward on the loan yields into 3Q.

James Beckwith (President and CEO)

Yeah, you'll see that. It was pretty much done, pretty much done.

Heather Luck (SVP and CFO)

Yeah

James Beckwith (President and CEO)

the last half of the quarter. And, so I think that'll carry forward into Q3 of 2024. You know, we'll be looking at, maybe doing some more of that, but, time will tell. But certainly, it'll carry forward in terms of, in terms of overall and impacting positively overall loan yields. Now, there's a lot of other things that's affecting our loan yields, too. That's loans that we're booking outside of the BHG purchase are have raised from 7.5-8.25 in a quarter also.

Heather Luck (SVP and CFO)

Yeah.

James Beckwith (President and CEO)

We had a pretty strong quarter for loan originations outside of this, what I would call a wholesale play. And we're also seeing some pay downs of the portfolio, lower rates being paid off. And so we're, you know, overall, that's really pushing loan yields up, as you can see in our, in our Q2 numbers.

Andrew Terrell (Managing Director and Research Analyst of Regional Banks)

Yep, got it. Okay, and then last for me, really quickly, just the SBA gain on sale income picked up this quarter. I was hoping you could just maybe update us as to what you're seeing within that business. Is this kind of lift upward in 2Q durable? And then just overall kind of expectations.

James Beckwith (President and CEO)

Yeah, we don't expect it to be durable. In fact, we've kind of trimmed the sales of the origination function. So, with our expectations about gains on a go-forward basis are certainly less in Q3 and Q4 that we saw in the first half of the year. So, we're, you know, we're-- we've diminished the import of that business. We're still an active lender, but we're not going to be originating any near the levels of volumes we've had historically. And so, our efforts from a loan origination perspective are really, you know, what we're doing down in the Bay Area and what we're doing in all our other verticals in terms of putting on credit. So gain on sales will definitely diminish.

You know, you're probably running from, you know, $50,000-$100,000 for the remainder of the year on a monthly basis.

Andrew Terrell (Managing Director and Research Analyst of Regional Banks)

Understood. Thank you for taking the questions. I'll step back in the queue.

James Beckwith (President and CEO)

Thank you, Andrew.

Operator (participant)

Our next question comes from Gary Tenner from D.A. Davidson. Please go ahead with your question.

Gary Tenner (Managing Director and Senior Research Analyst)

Thanks. Good morning.

James Beckwith (President and CEO)

Hey, Gary.

Gary Tenner (Managing Director and Senior Research Analyst)

First off, I wanted to ask. Hey, I wanted to ask about the expense run rate. You know, decent quarter-over-quarter pickup. It doesn't look like there was anything particularly unusual in the numbers, so, was curious for your thoughts for the back half of the year here.

Heather Luck (SVP and CFO)

Yeah. So, I was a little short, I think, whenever we did our estimate. We had a few more events and just overall conferences that we attended in Q2, so that drove our expenses a little higher. So I think for the run rate for the rest of the year, you can add about $250,000 per quarter to what we incurred in Q2. I think that'll be a good run rate for the rest of the year. You know, we do have some exciting things happening in Q3. You know, we'll do our big celebration for our grand opening of our San Francisco branch in September. So we'll have that as an added expense and then some employee celebrations and things like that.

I think $250 would be a good run rate each quarter of an additional expense.

Gary Tenner (Managing Director and Senior Research Analyst)

Okay, appreciate it. And then,

Heather Luck (SVP and CFO)

Mm-hmm.

Gary Tenner (Managing Director and Senior Research Analyst)

On the deposit side, you talked about the split between, you know, kind of the net growth in non-wholesale deposits, which was positive for the quarter, but obviously, the loan growth well outpaced that. So I just, you know, I'm trying to get a sense of kind of your target comfort level on wholesale funding percentage, where you are right now. And I guess similar question around the loan deposit ratio, which is a little over 100% right now.

James Beckwith (President and CEO)

Sure. We'll continue to lean into wholesale deposits as a source of funding. You know, we did put on a $75 million broker deposit towards the end of the quarter. You know, we're going to... And we do anticipate rates declining, so that particular type of funding may be more attractive as we look at the remainder of the year. But it is a tool. You know, we could, you know, Gary, if we wanted to, we could, you know, have a loan deposit ratio that's significantly less than what it is right now because we have the availability to do so.

We're trying to make sure that we act prudently, really try to protect our margin, make, and then, but also make sure we have appropriate liquidity to fund the loans that have come on. You know, historically, we've operated at, you know, less than 100% loan-to-deposit ratio. And, you know, we're looking to kind of target, you know, 95% loan-to-deposit ratio. And we could get there tomorrow if we chose to, but we're really just trying to grow our core deposits, and we've been successful in that. But, we just, we need to see to continue to stay at it, and, hopefully we'll see some more visibility of that in Q3 and Q4.

Gary Tenner (Managing Director and Senior Research Analyst)

Great, thanks. Thank you very much.

Operator (participant)

Our next question comes from Woody Lay from KBW. Please go ahead with your question.

Woody Lay (VP)

Hey, thanks for taking my question. Wanted to-

James Beckwith (President and CEO)

Hey, Woody.

Woody Lay (VP)

Hey! Wanted to start on the deposit growth you saw with the Bay Area team. I mean, it was really strong in the quarter. Could you just sort of walk through the traction you're getting in those markets and how you expect growth to trend in the back half of the year in the Bay Area?

James Beckwith (President and CEO)

Well, we expect it to be similar or even higher than it was in Q2 rolling into Q3 and Q4. You know, we've added a lot more talent and some pretty, pretty big producers, historically big producers at their previous financial institutions. So we kind of like where we're going in terms of the traction that we're getting within the Bay Area. It's still, you know, in San Francisco, proper, and I'm going to say throughout the Bay Area, although you could argue there's, you know, down in San Jose, in the South Bay, it's pretty stable, but it's still pretty much in turmoil. And that just creates opportunities for us.

You know, the conversion that JPM Chase had in the second quarter, I think it was over the Memorial Day weekend, Woody from, you know, the old FRB platform into the Chase's platform, that, you know, that didn't go necessarily well from what we hear from our prospects. And so we think that we'll be able to continue to take advantage of that transition, and especially since we've hired a lot of folks who are ex-First Republic folks who have deep relationships. We're very excited about where we think we can take growth in that market, and we're spending a lot of time down there. You know, personally, our grand opening is gonna be the last week of September for our offices, which is in the downtown financial district of San Francisco.

A lot of outreach is going on right now, and it's exciting times for us down there.

Gary Tenner (Managing Director and Senior Research Analyst)

That's great to hear. Any commentary on the loan growth trends you're seeing in those markets?

James Beckwith (President and CEO)

Let's see. We've had, you know, in terms of the teams that we brought in, total loan commitments of... What was that, Sarah?

Sarah Brock (SVP and Director of Financial Reporting and Analytics)

Eighty-five.

James Beckwith (President and CEO)

$85 million total loan commitments. Now, that's not all outstanding, but that's what we're seeing. We do expect it for that operation to be a net contributor to liquidity of the overall entity. And with our pipelines in terms of our composite pipelines down there are very strong, and our loan pipeline down there is very strong. So, you know, we're excited about the good work that our new team members are putting in down there. And it's just a great group of new clients that we're bringing on, and it's awfully exciting to see that market traction down there. Our leader down there, D.J. Kurtze, is doing a great job, and you know, we appreciate what the whole team is doing down there.

Gary Tenner (Managing Director and Senior Research Analyst)

Yep. That's great to hear. Maybe shifting over to the margin, you know, took a pretty sizable step up in the second quarter. Just what's the outlook for the third quarter? Just trying to get a sense of what the pull-through could be in the third quarter. If we see another step up in the third quarter, just what the expectation is.

James Beckwith (President and CEO)

I think it's gonna kinda moderate a little bit, so we're gonna we're thinking, three forty to three forty-five. You know, as we for the third quarter, you know, hopefully, we'll be able to do better than that, but that's what our sense of it is right now. And we'll just have to see how that goes. In terms of, you know, our margin, you know, we it is impacted, you know, by, you know, a greater reliance, or a greater outstanding of, of wholesale deposits, because you're fundamentally getting those deposits right on the marginal cost, which is, you know, right now, about five and a quarter.

So the extent that we do more of that, you know, will have an impact on our margin, but we hope that, you know, our core deposit generation will accelerate in the third quarter. But that's our sense of it right now, Woody, is 3.40%-3.45%.

Gary Tenner (Managing Director and Senior Research Analyst)

Oh, all right. Thanks for taking my questions. Good luck with the grand opening.

James Beckwith (President and CEO)

Thank you.

Operator (participant)

Thank you. Once again, if you would like to ask a question, please press Star and then one. To withdraw your questions, you may press Star and two. That is Star and then one if you'd like to join the question queue. Ladies and gentlemen, at this time and showing no additional questions, I'd like to turn the floor back over to management for any closing remarks.

James Beckwith (President and CEO)

Great, thank you. Five Star Bancorp is on a continued path of growth as we execute on strategic initiatives, which include growing our verticals and geographies while attracting and retaining talent. Our people, technology, operating efficiencies, conservative underwriting practices, and expense management have also contributed to the successes we share with our employees and shareholders. These successes include numerous ratings and awards. In the first half of 2024, we were recognized with the 2024 Greater Sacramento Economic Council Sustainability Award and 2023 Raymond James Community Bankers Cup. In addition and additionally, we were listed among S&P Global Market Intelligence 2023 Top 20 Best Performing Community Banks in the nation.

Our company leadership was also recognized in the first half of 2024 with the Sacramento Business Journal Women Who Mean Business Award, a Sacramento Business Journal C-Suite Award, a National Association of Women Business Owners Outstanding Women Leadership Executive Board, an Independent Community Bankers of America 40 Under 40 Emerging Community Bank Leaders Award. Five Star Bank continues to be a driving force of economic development, a trusted resource for our customers, and a committed advocate for our communities. We look forward to speaking with you again in October to discuss earnings for the third quarter of 2024. Have a great day, and thank you for listening.

Operator (participant)

Ladies and gentlemen, that does conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.