Earnings Call Transcript - FSBC Q4 2023

Operator, 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. 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, President and CEO

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 continues. 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 will 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. The 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 Luck, Senior Vice President and CFO

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 the 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, President and CEO

Thank you, Heather. I want to thank everyone for joining us as we discuss the 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.

Operator, Operator

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

Woody Lay, Analyst

Hey, good morning, guys.

James Beckwith, President and CEO

Hey, Woody.

Heather Luck, Senior Vice President and CFO

Hi, Woody.

Woody Lay, Analyst

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, President and CEO

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 about when the first one is going to occur. But if that happens, and we are slightly liability sensitive, 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, Analyst

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, President and CEO

Yes, we are anticipating an 8% growth in loans and a 10% growth in deposits as we enter 2024, which has been our goal for the past four quarters. In fact, our loan growth may have exceeded 8%, potentially reaching over 10%, while deposit growth was about 9% in 2023. We aim to achieve 10% deposit growth and 8% loan growth and believe we are fully capable of accomplishing this through our business development efforts.

Woody Lay, Analyst

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

James Beckwith, President and CEO

I expect they will continue their previous performance in 2023. I think around 30% to 40% of our loan growth will come from that area, which includes RVs, RV parks, and storage. That's our current outlook.

Woody Lay, Analyst

Got it. All right. That's all for me. Thanks for taking my questions.

James Beckwith, President and CEO

Thanks, Woody.

Operator, Operator

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

Andrew Terrell, Analyst

Hey, good morning.

James Beckwith, President and CEO

Hey, good morning, Andrew.

Heather Luck, Senior Vice President and CFO

Hi, Andrew.

Andrew Terrell, Analyst

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, President and CEO

Yes. There were 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, we had an ever-so-slight decline. And I think it was a lot of effort to get to that, too.

Andrew Terrell, Analyst

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, Senior Vice President and CFO

Yes. The spot rate was 2.48 at year-end.

Andrew Terrell, Analyst

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, President and CEO

We are quite familiar with the team from California Bank of Commerce operating in the capital region, as many of them previously worked at Wells Fargo. They are a strong group of professionals, especially in commercial and industrial sectors. While I haven’t spoken to them yet, I plan to do so soon. We remain open to opportunities and there is talent worth considering, not only in that region but also in the Bay Area, where we see potential for growth. I anticipate that we will make additional business development hires in the first half of 2024, as we are preparing for that. In summary, we intend to strengthen our capabilities in the markets we operate in.

Andrew Terrell, Analyst

Good deal. Do you have a target in mind of what you would kind of target in terms of new hires in the first half or for the year?

James Beckwith, President and CEO

I believe we will likely add two to four new business development personnel as we approach the end of January. In 2023, we shifted our approach to be more opportunistic in hiring talent. As the year progresses and as transactions occur, we want to remain open to opportunities. For now, I think aiming for two to four new hires is a reasonable goal.

Andrew Terrell, Analyst

Yes. Okay. And then maybe last one for me for Heather. Just I mean, kind of throughout this year, you've done a really good job managing the expense base. Just as you look into 2024, any thoughts on expense run rate into next year and then overall kind of expense growth you'd be looking out for '24?

Heather Luck, Senior Vice President and CFO

Thank you for that. We take pride in managing expenses and being mindful in that regard. Looking at 2024, specifically Q1, you can expect an increase of about 250,000 compared to what we had in Q4. That seems like a good estimate for where we’ll start to stabilize. There might be a slight increase in the second half of the year as we account for rent expenses from the new Bay location. However, if you project an increase of around 250,000 to 500,000 for the first half of the year, that should be sufficient.

Andrew Terrell, Analyst

Okay. Very good. I appreciate it. Thank you, guys, for taking the questions.

James Beckwith, President and CEO

Thank you, Andrew.

Operator, Operator

The next question is from Gary Tenner with D.A. Davidson. Please go ahead.

Gary Tenner, Analyst

Thanks. Good morning.

Heather Luck, Senior Vice President and CFO

Hey, good morning, Gary.

Gary Tenner, Analyst

Going back to the Bay Area team. They've been on board for, call it, two quarters and something over $70 million of deposits, I think, in the door. Where does that seem relative to kind of the year-end expectations that you had in mind for them? And maybe beyond that, can you talk about just the deposit trends outside that team?

James Beckwith, President and CEO

Sure. It was twice what we anticipated. They performed exceptionally well, and collaborating with them has been great. We dedicated a lot of time to helping them onboard their customers and strengthen their relationships. We expect that growth to continue, potentially at a similar rate. Looking ahead to December 31, 2024, we hope to double the deposit base from where it was at December 31, 2023. Regarding growth beyond the Bay Area, we're enthusiastic about our progress across all our sectors, and we're off to a solid start. I believe this will support our target of 10% deposit growth. We are also making significant strides in our Special District business, which is exciting. Additionally, our professional services nonprofit sector seems to be performing well, and our core commercial and industrial business, particularly in construction, is showing promising deposit growth. Overall, I think all our sectors will successfully achieve deposit growth. We are still collaborating with our healthcare practice group and expect a solid outcome in Q1. However, we want to invest more time in that particular sector to ensure it gains momentum.

Gary Tenner, Analyst

Thanks. I appreciate that, James. And then just a follow-up. I think in your prepared remarks, I don't remember the exact term, phrase you used, if there was a risk on the horizon or storm clouds on the horizon, but can you talk about kind of your broader view that maybe kind of note that in your prepared remarks and kind of your confidence in the underlying economy in your core markets?

James Beckwith, President and CEO

There is still a significant amount of uncertainty regarding the economy and whether we will experience a soft landing or a mild recession. It's difficult to predict. Hopefully, as each quarter passes, we will continue to see strong national GDP without a substantial rise in unemployment. In California, our markets remain robust, although we do face some challenges related to commodity prices in our agricultural business; however, we are managing those issues. Many of our farmers grow a variety of crops, which helps mitigate risks. That said, I want to remain cautious in my comments. It's challenging to find a business publication that doesn't discuss interest rates and the prospects of a recession, creating a constant influx of information that shapes people's views on when the Federal Reserve will act. I would prefer that things stabilize a bit. There is a national election introducing uncertainty, coupled with geopolitical events around the world that could impact our economy. Overall, I think we need to approach the situation with a sense of comprehensive caution, considering all these factors.

Gary Tenner, Analyst

Great. Appreciate your thoughts, James.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference 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 our 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 employees and shareholders. These successes include numerous ratings and awards. In 2023, we received a Findley Reports Super Premier Performing Rating and IDC Superior Rating, Bauer Financial Superior Rating, 5 stars out of 5. We were also awarded the prestigious 2022 Raymond James Community Bankers Cup, and we are among the 2023 Piper Sandler Sm-All Stars. In 2023, we were recognized as the 2022 S&P Global Market Intelligence Number 1 Best-Performing Community Bank in the nation. That's with banks with asset size between $3 billion and $10 billion. We were also listed on Independent Banker's Top Commercial Banks in 2023, with banks more than $1 billion in assets, and ranked number six in the nation. We were listed among American Banker's Top-Performing Banks in 2023, banks with $2 billion to $10 billion in assets, and ranked number 12. In 2023, our executives and senior leaders were awarded a Sacramento Business Journal C-Suite Award, a Sacramento Bee Latino Changemakers Award, a Commercial Real Estate Women Award, a Comstock Magazine's Women in Leadership Award. Being recognized as community leaders ensures Five Star Bank remains top of mind in the markets we serve as we continue to build out our verticals. We are humbled and proud of our team's accomplishments. We look forward to speaking with you again in April to discuss earnings for the first quarter of 2024. Have a great day, and thank you for listening.

Operator, Operator

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