Five Star Bancorp Q1 FY2024 Earnings Call

Welcome to the Five Star Bancorp First Quarter Earnings Webcast. Please note, this is a closed conference call, and you are encouraged to listen via the webcast. 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 31, 2023, and in particular, the information set forth in Item 1A, Risk Factors. 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 figures 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's President and CEO. Please go ahead.

Thank you for joining us to review Five Star Bancorp's financial results for the first 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 wasn't 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 first quarter with the announcement of our underwritten public offering of 3.45 million shares of the bank's common stock and underwriters' option to purchase up to an additional 517,500 shares, with the intention of using the net proceeds for general corporate purposes, to support our continued growth and for working capital. We also added 5 more seasoned professionals to support our expansion in the San Francisco Bay Area market and continue to add new core deposit accounts and relationships, as evidenced by an increase of non-wholesale deposits of $112 million in the three months ended March 31, 2024. Despite continued external headwinds, we maintained our ability to conservatively underwrite as evidenced by a 50% loan-to-value ratio on commercial real estate, managed expenses with a 45% efficiency ratio, and delivered value to our shareholders with a $0.20 per share dividend for the fourth quarter of 2023 and the first quarter of 2024. The first quarter of 2024 exhibited continued margin compression, although slowing compared to prior quarters; we remain focused on the execution of our organic growth strategy and were able to maintain earnings and expense management trends during the quarter. Loans have consistently grown since prior periods. The decrease in deposits and total assets during the quarter is the result of relying less on wholesale deposits and short-term borrowings, which positions us well for future growth. Our pipeline continues to remain solid at the end of the first 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 $22.4 million or 0.73% from the prior quarter, primarily within the consumer concentration of the loan portfolio. Loan originations during the quarter were approximately $149.9 million, while payoffs and pay downs were $77.2 million and $50.3 million, respectively. Asset quality continues to remain strong; though non-performing loans increased beginning in the third quarter of 2023, they continue to represent only 0.06% of the portfolio at the end of the first quarter and totaled $34.7 million. We recorded a $0.9 million provision for credit losses during the quarter, primarily related to the net effect of charge-offs, increases in qualitative reserves and reductions in reserves were qualitative factors. The ratio of the allowance for credit losses to total loans for investment was 1.12% at quarter end. Loans designated as substandard totaled approximately $1.9 million at the end of the quarter, which was a decrease from the $2.0 million at the end of the previous quarter. During the first quarter, deposits decreased by $71.7 million or 2.35% as compared to the previous quarter. Noninterest-bearing deposits as a percentage of total deposits at the end of the first quarter increased slightly to 27.7% from 27.5% at the end of the previous quarter. As noted earlier, we are pleased we had net non-wholesale deposit inflows for the three months ended March 31, 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 relations; we believe we have 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 58% of total deposits. The average age of these accounts was approximately 9 years. Local agency depositors accounted for approximately 24% of deposits as of March 31, 2024. Overall, deposit balances have decreased when compared to the prior quarter as a result of our focus to rely less on costly wholesale deposits. Wholesale deposits, which we define as broker deposits and public time deposits, decreased by $183.1 million. Non-wholesale deposits increased by $112 million, driven by a $125.7 million increase in interest-bearing deposits partially offset by a $13.7 million decrease in noninterest-bearing deposits. Cost of total deposits was 253 basis points during the first 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 9.07% to 9.13% between December 31, 2023 and March 31, 2024. On April 19, we announced the declaration by our Board of Directors of a cash dividend of $0.20 per share on the company's voting common stock, expected to be paid on May 13, 2024 to shareholders of record as of May 6, 2024. On that note, I will hand it over to Heather to discuss the results of operations. Heather?

Thank you, James, and hello, everyone. Net income for the quarter was $10.6 million; return on average assets was 1.22% and return on average equity was 14.84%. Average loan yield for the quarter was 5.71%, representing an increase of 7 basis points over the prior quarter. Our net interest margin was 3.14% for the quarter, while net interest margin for the prior quarter was 3.19%. Fed rate increases in 2023 continue to put pressure on deposit costs. As a result of changes in interest rates and other factors, our other comprehensive loss was $0.7 million during the three months ended March 31, 2024, as unrealized losses, net of tax effect, increased on available-for-sale debt securities from $11.8 million as of December 31, 2023, to $12.4 million as of March 31, 2024. Noninterest income decreased to $1.8 million in the first quarter from $1.9 million in the previous quarter, due primarily to reductions in gains from distributions on investments in venture-backed funds and the recognition of rate lock and swap referral fees during the three months ended March 31, 2024. These decreases were partially offset by a reduction in net losses on the sale of securities, which did not occur in the first quarter of 2024. Noninterest expense grew by $53,000 in the three months ended March 31, 2024, compared to the three months ended December 31, 2023. This was primarily due to an increase in salaries and employee benefits, partially offset by declines in advertising and promotional expenses as well as other operating expenses 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.

Thank you, Heather. I want to thank everyone for joining us as we discuss first 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 the 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 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 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 be happy to take any questions that you might have.

The first question today comes from Andrew Terrell with Stephens.

Just a couple on deposits for me. When did the runoff in the brokered deposits and in public fund time deposits occur during the quarter? I mean, do you have the weighted average cost of those deposits?

As we entered the first quarter of the year, our weighted average rate on wholesale deposits was approximately 5.26% with a balance of around $360 million. However, during the latter half of the quarter, we experienced a significant runoff of these wholesale deposits. Currently, our weighted average rate has decreased to 5.12%, with a total balance of $177 million.

Yes. Can you discuss the impressive remix this quarter? You have approximately $177 million remaining in wholesale. Could you remind us of the deposit growth expectations for the year? Additionally, do you anticipate any further decrease in the wholesale deposits within that deposit guidance?

Sure. We're aiming for a 10% deposit growth and expect to reach that target. This projection accounts for the runoff in wholesale deposits during Q1. Currently, I don't anticipate significant further runoff of wholesale deposits; they will likely remain stable for the rest of the year, but we'll evaluate this on a quarterly basis. We are pleased with our current position, especially in maintaining relationships, particularly with California. Additionally, I believe we will have a small amount of brokered deposits remaining in July.

$42 million.

$42 million, which hopefully we'll be able to eliminate that. But nothing probably greater than that, Andrew.

And then could you maybe just compare and contrast for the non-wholesale deposit growth. I think it was $112 million or so this quarter. Just the weighted average costs you're bringing kind of new money on the balance sheet today versus what we saw roll off in the first quarter?

Sure. Many of the balances we're currently acquiring are interest-bearing. If I combine our expectations for noninterest-bearing and interest-bearing deposits, the weighted average rate is likely just under 3%. The interest-bearing accounts probably have a rate close to 4%. If we are successful in increasing noninterest-bearing deposits for the rest of the year, primarily through new relationships, that will help lower those figures. I believe our efforts in San Francisco regarding the yields we offer to deposit customers are significant. Heather, do you have that data, or should I recall it from memory?

Close to 3%.

Yes, it's a little shy of 3%, 2.77%. I think that was in DJ's deck. So that's kind of what we're looking at right now in terms of what we're bringing on for these new relationships. And Andrew, it's important to note that as we bank these new customers across our entire footprint, we're really after their operating accounts and their liquidity. So we look at things in totality in terms of cost of funds. So if we can pay somebody 4% for the liquidity and just bank their transactional account, if you will, that we think that's a winning strategy. And hopefully, we can deliver the entire relationship sub-3%.

I totally appreciate that. Understood. If I could ask just one last one. Heather, around the margin. Do you have the margin in the month of March?

Oh, in the month of March, yes. Our net interest margin for March was about 3.18%.

The next question comes from Gary Tenner with D.A. Davidson.

I wanted to ask on the expense side. What the near-term thinking is on expense levels, kind of fully loaded for new hires?

Yes. So I think if we look at for Q2, I think if we add about $500,000 for Q2 expenses to what we incurred for Q1, that should put your model in good shape there. We do have some new hires, but then also some expenses for conferences that we have run through that are a little bigger than Q1.

And our advertising spend is going to go up in the second quarter and the third quarter and fourth quarter as we continue to develop the Bay Area.

And then I may have missed this answer you said. I heard you mention, I think, the March NIM, Heather, but did you provide the spot rates as of March 31? If you did, I apologize for missing it.

No, sure. The spot rate for cost of deposits was $2.49.

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

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 success we share with our shareholders and employees. These successes include numerous ratings and awards. In the first quarter, the company's leadership was recognized by the Sacramento Business Journal on the Power 100 list and the Women Who Mean Business list. Company leadership also received the National Association of Women Business Owners, Outstanding Women Leaders, Executive Women Award. Also in the first quarter, two of our customers were recognized by the Sacramento Small Business Administration in the categories of Family-owned Small Business of the Year and Minority Small Business Champion. Five Star Bank continues to be a driving force for economic development, a trusted resource for our customers, and a committed advocate for our community. We look forward to speaking with you again in July to discuss earnings for the second quarter of 2024. Have a great day, and thank you for listening.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.