Q3 2022 Five Star Bancorp Earnings Call

Good day, everyone and welcome to the five Star Bancorp third quarter earnings webcast.

Please note. This is a close conference call and you are encouraged to listen via the webcast.

After todays presentation, there will be an opportunity for those provided with the dial in number to ask questions.

To ask a question you May press Star then one on your telephone keypad to.

Withdraw your question you May press Star 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.

Including the continuing impact of the COVID-19 pandemic.

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.

See the company's annual report on Form 10-K for the year ended December 31, 2021, and in particular, the information set forth in item one a risk factors therein.

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 as.

As well as reconciliations to non-GAAP financial measures to the most directly comparable GAAP figures, which is included in the appendix to the presentation.

Please note this event is being recorded.

And at this time I would like to turn the floor over to James back with <unk>.

Five Star Bancorp, President and CEO . Please go ahead.

Thank you for joining us to review five Star Bancorp's financial results for the third quarter of 2022.

Joining me today is Heather lock 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.

A copy of the release please visit our website at <unk> Dot com and click on the Investor Relations tab.

And the company overview section, we have provided a brief overview of our geographic footprint and executive management team.

The third quarter of 2022 exhibited continued execution of our organic 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.

It's the prior periods.

Sure.

Our pipeline continues to remain substantial at the end of the third quarter of 2022 within the verticals we have historically operated in.

As presented in the loan portfolio diversification slide.

Loans held for investment increased during the quarter by $202 5 million or 851% from the prior quarter.

Primarily within the commercial real estate concentration of the loan portfolio.

Loan originations during the quarter were approximately $321 3 million in payoffs were $118 7 million.

All PPP loans have been forgiven or paid off by the borrower at September 30.

2022.

Asset quality continues to remain strong with nonperforming loans representing.

The only 0.0% to 2% of the portfolio slightly decreasing from the last several quarters.

At quarter end, there were no loans on COVID-19 deferment.

At the end of the third quarter the allowance for loan losses totaled 27 8 million.

We recorded a $2 3 million provision for loan losses during the quarter.

Primarily related to loan growth.

The ratio of the allowance for loan losses to total loans was 1.08% at quarter end.

Loans designated as sub standard totaled approximately <unk> 5 million at the end of the quarter, representing a decrease in sub standard loans of approximately <unk> 8 million from the previous quarter.

Now that we have discussed the loan portfolio I will hand, it over to Heather to discuss deposits capital and the results of operations Heather.

Thank you James and Hello, everyone.

During the third quarter deposits increased by $113 million.

Five 2% as compared to the previous quarter.

Non interest bearing deposits as a percent of total deposits at the end of the third quarter decreased to 39% from 42% at the end of the previous quarter.

We have had strong deposit growth over the last several quarters with deposit balances increasing when compared to the prior quarter.

Non interest bearing deposits increased by $14 6 million, while interest bearing deposits increased by $98 5 million.

The cost of total deposits was 43 basis points during the third quarter.

We continue to be well capitalized with all capital ratios well above regulatory thresholds for the quarter.

Additionally, we completed a private placement of $75 million in aggregate principal amount.

Fixed to floating rate subordinated notes due September one 2032 on August 17.

Net proceeds received from the subordinated note net of debt issuance costs and required debt servicing reserve will be used to redeem $28 8 million of previously existing subordinated notes on December 15 2022.

With the remaining $39 million downstream to five star bank during the quarter.

Net income for the quarter was $11 7 million return on average assets was one 6%.

And return on average equity was $19 three 5%.

New loan originations drove increases in the daily average balance of loans period over period.

Average loan yield for the quarter with $4 seven 4%, representing an increase of 27 basis points over the prior quarter.

As a result of these factors our net interest margin was 384% for the quarter, while net interest margin for the prior quarter was three 7%.

The change in the yield curve as a result of interest rate hikes that occurred during the quarter had a negative impact on the companys accumulated other comprehensive income during the quarter and the amount of $4 7 million.

Primarily in our mortgage backed and municipal securities portfolio, resulting in decreases to each of those portfolios of $3 million and $1 7 million respectively.

This press the decline in tangible book value per share, which is a non-GAAP financial measure discussed in our press release.

This decline was offset by increases to tangible book value per share due to an increase in equity as a result of net income earned in the quarter for a net increase in tangible book value per share of 35%.

Noninterest income decreased to $1 5 million in the third quarter from $2 million in the previous quarter due primarily to $8 3 million dollar decrease in gain on sales loans.

Relating to lower volumes of loans sold during the quarter.

$8 $2 million decrease in loan related fees due to lower swap referral fees earned during the quarter.

Noninterest expense remained relatively flat quarter over quarter with increased professional services.

$2 million related to legal expenses incurred for corporate organizational matters completed in 2022.

By declines in other operating expenses of <unk> 3 million related to reduced travel expenses incurred during the quarter related to a tenant that professional events conferences and other business related travel combined with $1 $1 million of lower loan related expenses incurred.

Now that we have discussed the overall results of operations I will now hand, it back to Jamie to provide some closing remarks.

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

The strength of the banks.

Third quarter financial results is emblematic of our reputation built on trust speed to serve and certainty of execution.

Which support our clients' success.

Our financial results are also the result of a truly differentiated customer experience.

Which powers the demand for five star banks relation ship based services.

We attribute the sustained success to our prudent business model.

Treating customers with an empathetic spirit understanding and care.

We're very proud to have earned the trust of those we serve including our shareholders.

Looking to the remainder of 2022 and 2023, we will be guided by a focus on shareholder value as we monitor market conditions.

We are confident in the company's resilience in any interest rate environment, and we will continue to execute on our organic growth strategy 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 you might have.

And ladies and gentlemen, we will begin the question and answer session. Once again to ask a question you May Press Star and then one using a touch tone telephone.

You are using a speaker phone, we do ask that you. Please pick up the handset prior depressing the numbers to ensure the best sound quality.

If you decide to withdraw your question you may do so by pressing star and then two.

Once again that is star and then wanted to join the question queue.

We will pause momentarily to assemble the roster.

And our first question today comes from Andrew <unk> from Stephens. Please go ahead with your question.

Hey, good morning, James Good morning, Heather.

Good morning, Andrew how are you doing good how are you guys.

Yeah.

We are here bright and shiny.

Hi, Ken.

Thanks for the time.

If I could start James.

On loan growth came in I think a bit.

Better than we anticipated this quarter and maybe a bit better than we spoke about on <unk>.

Last quarter's call I hear your comments about kind of strength and resiliency in our pipeline I'm. Just curious if you could maybe provide us kind of expectation for growth in the fourth quarter.

Assuming we should we should think about a moderation from here, but would love to hear your thoughts on the cadence of loan growth moving forward and then any specific areas of the portfolio that you think will drive that strength.

Sure.

We did experience.

Strong loan growth in the third quarter and as we roll into the fourth the fourth quarter.

We're into it already.

We don't expect our loan growth to be the same but it is still be it will still be decent.

Our pipeline right now as we sit here today, Andrew is substantially less than what it was at its peak.

And so we expect and we have seen things slow down.

And all of our segments and all of our verticals.

I think that.

The opportunities for loan growth.

<unk> loan growth as it has been at five Star Bank I think those are waning.

But we still expect decent loan growth as we move forward, we're very comfortable.

With the 10% to 15% loan growth on an annualized basis as we move forward, finishing up.

2022, and more importantly, rolling into 2023.

What's happened in the commercial real estate spaces is that cap rates have increased obviously interest rates have increased.

So deal volume is just off across all segments.

And.

That's going to cause I think some slowdown in loan growth now the business is still there.

Hey.

But not in the same degree as it was throughout 'twenty and the first three quarters of 2022.

Yeah understood I appreciate that.

And as you think about got it.

Being comfortable at 10, 15 kind of percent loan growth range.

The other side of the balance sheet I know deposit growth has been kind of tougher across the industry.

The past couple of quarters do you think going forward you can you can kind of core fund.

Level of that level of loan growth and can you maybe speak to just what youre seeing from a deposit perspective within your growth pipeline.

Sure. We believe we can fund that with core deposits.

For the remainder of the year and also as we roll into 2023.

Good.

It gets me comfortable about excuse me comfortable about that statement. Andrew is that we have a very well developed business development team. We have 20 people that that's what they do that's their job.

And we think we're unique in that respect and.

We have the right incentives we have the right technology, we have the right service capability.

To be really really to grow our core deposits. So I feel pretty confident that we'll be able to do that.

Certainly it's an area of emphasis right now is probably top of the top of the number one thing that we're trying to do right now is grow deposits grow core deposits. So it's certainly got all of our attention and all of our efforts to do that so.

I feel very confident that we'll be able to achieve that okay.

Okay, and probably in the neighborhood of <unk>.

Im going to say slightly more than our loan growth.

That's what we're planning in 2023.

To have a deposit.

Posit growth of anywhere between 2% to 4% greater than our loan growth.

Okay.

That's helpful color I appreciate it.

Maybe if I could shift gears.

<unk>.

Heather on the noninterest expense.

Came in a bit better than that.

And we are forecasting.

I'm curious kind of your expectations I know, there's probably a lot of moving pieces in.

Inflation and everything just curious your expectations on the expense base.

Is this a good kind of run rate heading into the fourth quarter and then can you remind us how we should think about kind of the cadence of expenses.

Throughout the year in 2023.

Sure so.

Q3 was a really good proxy for where we think expenses are going to land for for Q4 from a as salaries perspective.

The wildcard is usually just timing of travel and timing of attendance as professional events.

So I believe Q3 should be a good proxy and then kind of as we grow we can kind of take that ratio.

<unk>.

<unk> expenses as a percent of total assets and kind of just walk us forward with that I think that would be a good good method for your model.

One item I do want to highlight though that we will see in Q4.

We will be recognizing a bow.

300000 of additional subordinated note debt issuance costs.

When we redeemed the original tranches of the subordinated note those were previously amortized to the maturity date, rather than the call date. So we will be recognizing about 300 Grand there.

Just to add onto that Andrew if I could.

Alright. Thank you are aware of this.

Is that we do have a carry on that $28 8 million of subordinated notes all the way through December 15th.

So we'll be dealing with that in the fourth quarter.

But not in 2023 so.

Just want to make sure you are aware of that.

Absolutely, but I appreciate the Fi okay. Thanks for taking my question and congrats on a good quarter I'll hop back in the queue.

Thank you.

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

Thanks, Good morning.

I wanted to go back to the questions about kind of loan deposit growth for the third quarter I think James on the call last quarter as well as maybe intra quarter there was.

The commentary around the deposit pipeline kind of running ahead of the loan pipeline.

Maybe an expectation that this quarter.

<unk> be able to fund or matched the growth of loans with deposits. So I guess I'm just curious what your deposit growth was obviously strong in last quarter was flat so stronger than that.

What is the loan growth or the net loan growth.

More of a positive surprise this quarter.

Versus the deposit growth being.

Disappointing if I put that in quotes.

Sure.

Yes.

It's a very fluid matter.

With respect to deal flow that we see.

We have a tendency to do some.

Some.

<unk> loans of $5 million to $10 million that will move the needle.

So they come up frequently and so we've taken advantage of those opportunities if they are priced well well structured and have great sponsorship and relative.

Safe loans so.

That was.

I think a nice surprise for us, but today as we sit Gary we still have a substantial deposit pipeline thats.

<unk>.

<unk>.

Significantly more than our loan pipeline that conditions still exist today.

Now.

I don't know if its wishful thinking, but I can tell you that.

Developing core deposits.

There is a lot more lengthy process, then making loans I think that the industry understands that also well.

And so.

Sometimes it takes to onboard a major customer it takes a lot longer.

So that's what exists in our deposit pipeline and those efforts are ongoing and it could take up to six to nine months, sometimes to onboard our deposit customer.

A substantial deposit customers. So I'm still very bullish on the fact that of us being able to grow core deposits and as we go forward.

Sure.

And especially in 2023, we expect our deposit growth to be greater than our loan growth.

I appreciate that I'm sure once those deposits are in the door or they are quite sticky, but I think conversion from pipeline to bringing them in house might be a little more fickle.

Fair.

Got it takes longer.

Yes.

And then just your comment on the 300000 I think you said of the sub debt costs for the so that youre going to redeem that.

Is that through noninterest expense or is that going to be through.

Through interest income.

That will be through interest income.

Okay, Great and 300000.

Alright, thank you.

And once again, if you would like to ask a question. Please press star and then one to withdraw your question you May press Star and two.

Our next question comes from Woody lay from <unk>. Please go ahead with your question.

Hey, good morning, guys.

Good morning.

The interest bearing deposit beta was a little over 30% in the quarter from my calculation do you think it's fair to expect that deposit beta to trend up in the quarters ahead or is this a pretty good run rate going forward.

Yes.

Looked at it.

On a quarterly basis on a monthly basis.

Inc.

30% beta is still a fair estimate is what youll see is a lot of our all of our pricing is customized.

And unique to each customer and so.

On a monthly basis, it will peak and valley, but it all even out about 30% for the quarter.

Got it.

And then I know there will be some noise in the NIM, just with the debt issuance and the redemption, but stripping out those moving parts how should we think about the NIM going forward do you think it's relatively stable or could we see some additional expansion from here.

Well.

Because we look at it we think it's going to be.

Anywhere between 383, 9% on a go forward basis as we roll into 2023.

And that's kind of what we're planning.

C.

And so we'll just.

Have to execute on that and what makes it.

Well I'm not going to say difficult to predict but certainly.

They have to understand how we price.

Our funding cost.

As I've mentioned.

Our relationships with our deposit customers, it's pricing is unique.

And especially in a rising rate environment. So.

I think we're going to be able to maintain that 30% deposit beta and also maintain our.

Our margins between three eight to $3 $9 on a go forward basis.

That's good to hear.

And then last is shifting to credit credit remains super clean from an NPA and classified one point of view as you talk to your borrowers with how are you feeling about the credit environment as we head into the fourth quarter.

We feel good about it but we're.

Very cautious also we recognize that.

Some of them some of our borrowers may have some stress.

But I think you need to look at.

When you look at the composition of our loan portfolio, we have a lot of mobile home community loans, and we think that asset class is very stable and in any economic environment.

So we think it's going to perform better in a recession than any other asset class. So we feel like we are a bit protected if you will.

Our office component, which is which is.

It is a concern.

It's certainly not our top CRE concentration in fact, it's probably well down the wrong at this point and very manageable.

So.

We're focused on that particular segment.

And we think that we've got good credits in there and good sponsorship so.

We're comfortable with our credit quality as we exist here today.

But we do understand that.

Dark clouds are ahead of us and we want to make sure. We're prepared if we're reserving appropriately.

And that any actions we may take on a credit we will act quickly.

To mitigate any downside risk.

Alright, great color.

Is all from me thanks, guys.

Thank you.

And our next question is a follow up from Andrew Terrell from Stephens. Please go with your follow up.

Hey, Thanks for the follow up I wanted to.

Dovetail off the last question on credit and just curious if you're altering.

<unk>.

I will take any of your underwriting standards, just kind of tightening the reins at all and kind of go forward credit or have you made changes more recently in terms of kind of.

Portfolio monitoring just contemplating kind of the current backdrop.

Yeah.

In terms of any.

Changes in our deal terms and whatnot I will tell you that we've increased our spreads.

And so that what that really forces.

Borrowers want to do business with us theyre going to have to put more money in every deal.

So theyre downpayments and their their sponsorship is going to be have to be that much more significant.

So.

From a.

We have solid underwriting practices.

To begin with but we have increased our spreads.

To compensate one for interest rate risk, but also we want to make sure that we're as we move forward and we're putting on credit at this particular point that it is very very solid.

There's business to be had but it's got to be really good business.

Okay, and then on capital.

CET one ratio kind of.

9% territory.

This quarter can you just remind us what your targeted capital metric is in.

I guess given kind of the current backdrop and your expectation for for balance sheet growth moving forward.

Is it fair to think that the capital ratio is kind of across the board build from this level.

Yes, as we look at our plan going out with Heather.

We're right in the middle of our planning process looking at our plan going out for five years.

We believe we will be able to grow our capital levels.

With a 10% loan growth factor.

So we're comfortable with that.

That scenario given our current payout ratios so we.

We think that will be we will be building tangible book value and regulatory capital.

Yes.

And do you have.

<unk> targeted.

<unk> targeted.

The metric, whether it's CET one or.

Total capital.

Just any targeted capital metric that you focus on.

Well historically, we've been very oriented towards total capital, we'd like it to be.

North of 11 target of 11, 5% to 12.

Tier one capital.

Now that we did another round of subordinated debt.

We're focused on trying to grow that to 10%.

We're not there yet.

To take a few quarters to get there, but thats our goal.

Okay.

Thanks for the follow ups.

And ladies and gentlemen, with that we've reached the end of today's question and answer session I would like to turn the floor back over to management for any closing remarks.

Great. Thank you Flagstar Bancorp is on a continued path of robust organic 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 employees and shareholders.

The five star Bancorp, we seize opportunities embraced challenges.

And value the intrinsic reward of serving others. We look forward to speaking with you again in January to discuss earnings for the fourth quarter of 2022.

Have a great day and thank you for listening.

And with that we'll conclude today's presentation. We do thank you for joining you may now disconnect your lines.

Yes.