Five Star Bancorp — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. Five Star Bancorp operates Five Star Bank, serving businesses, professionals and individuals primarily in Northern California. Figures below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q3 2022 / Sept. 30, 2022 | Comparable period / Dec. 31, 2021 |
|---|---|---|
| Net income | $11.7 million; diluted EPS $0.68 | Q3 2021: $11.0 million; $0.64 diluted EPS |
| Nine-month net income | $31.5 million; diluted EPS $1.84 | Nine months 2021: $31.1 million; $2.18 reported EPS; $1.86 pro forma C-corporation EPS |
| Net interest income | Q3: $27.4 million; nine months: $73.8 million | Q3 2021: $19.9 million; nine months 2021: $56.3 million |
| Net interest margin | Q3: 3.84%; nine months: 3.72% | Q3 2021: 3.60%; nine months 2021: 3.63% |
| Provision for loan losses | Q3: $2.3 million; nine months: $5.5 million | Q3 2021: none; nine months 2021: $0.2 million |
| Non-interest income / expense | Q3: $1.5 million / $10.2 million; nine months: $5.7 million / $30.0 million | Q3 2021: $2.0 million / $8.6 million; nine months 2021: $5.5 million / $27.0 million |
| Assets / loans held for investment / deposits | $3.075 billion / $2.583 billion / $2.614 billion | Dec. 31, 2021: $2.557 billion / $1.934 billion / $2.286 billion |
| Cash and cash equivalents | $317.7 million | Dec. 31, 2021: $425.3 million |
| Allowance for loan losses | $27.8 million; 1.08% of loans held for investment | Dec. 31, 2021: $23.2 million; 1.20% |
| Subordinated notes / FHLB advances | $102.0 million / $105.0 million | Dec. 31, 2021: $28.4 million / none |
| Shareholders’ equity | $239.3 million; 7.78% of assets | Dec. 31, 2021: $235.0 million; 9.19% of assets |
- For the nine months, operating cash flow was $27.5 million; investing cash outflow was $629.4 million, primarily reflecting net loan growth; financing cash inflow was $494.3 million. Cash declined by $107.7 million.
- Q3 return on average assets was 1.60% and return on average equity 19.35%; efficiency ratio was 35.13%. Nine-month figures were 1.53%, 17.85% and 37.68%, respectively.
- At September 30, the Company’s total risk-based capital ratio was 13.94% and Tier 1 leverage ratio 8.66%. The Bank’s corresponding ratios were 12.51% and 10.80%; the Bank remained “well-capitalized.”
Material changes and drivers
- Loans held for investment grew 33.5% from year-end, driven principally by a $634.0 million increase in commercial real estate loans. Commercial real estate, land/development and construction loans together represented 89.38% of held-for-investment loans.
- Deposits grew $328.4 million, or 14.4%, from year-end. Non-interest-bearing deposits were 39.04% of total deposits. The loan-to-deposit ratio rose to 99.22% from 85.09%.
- Q3 net interest income rose 37.8% year over year, supported by higher interest income on larger loan balances and rate-sensitive bank deposits and securities. Deposit and borrowing costs also rose; Q3 cost of funds increased to 0.62% from 0.17%.
- Q3 non-interest income declined 24.5% year over year, mainly because prior-year securities-sale gains did not recur and gains on loan sales were lower. Nine-month non-interest income increased 4.1%, including higher loan-related fees.
- The allowance increased by $4.6 million from year-end after $5.5 million of provision and $0.9 million of net charge-offs. Allowance coverage declined as loans grew faster than reserves.
- Accumulated other comprehensive loss widened to $16.1 million from $0.6 million, primarily reflecting unrealized securities losses from rising interest rates. Management said it did not intend, and did not expect to be required, to sell the securities before recovery or maturity.
Outlook, risks and unusual items
- Management expects continued loan-portfolio growth and said product and geographic concentrations are not expected to change materially. It believes liquidity sources are adequate for the next 12 months and expects to continue quarterly dividends, subject to board discretion. It also anticipated efficiency-ratio improvement, partly from prior infrastructure investment; no numeric earnings or margin guidance was provided.
- Key exposures include Northern California and commercial real estate concentration, rising interest rates, borrower repayment and collateral values, deposit competition and withdrawals, and the ability to maintain liquidity and capital. Real estate-related loans were 92.63% of held-for-investment loans.
- Deposit funding is concentrated: 88 relationships exceeding $5 million represented 62.42% of deposits; the largest relationship was $200.2 million, or 7.66%. Uninsured deposits were approximately $1.3 billion. Management cited correspondent lines and other liquidity sources as mitigants.
- Available-for-sale securities had $22.9 million of gross unrealized losses at quarter-end, principally attributed to interest-rate movements. The Company reported no other-than-temporary impairment.
- The August 2022 private placement added $75 million of subordinated notes at a 6.00% fixed rate through September 2027, then floating. Two earlier subordinated note issues totaling about $28.8 million were subject to redemption notices issued November 5, 2022, with redemption scheduled for December 15, 2022.
- Q3 tax expense was $4.8 million and nine-month expense $12.6 million. Comparisons with 2021 are affected by the May 2021 conversion from S-corporation to C-corporation status and a $4.6 million deferred-tax benefit in 2021.
- CECL credit-loss accounting was scheduled for adoption in 2023. Management said adoption could increase the allowance but could not yet quantify the impact. The filing also notes an FDIC deposit-insurance assessment increase beginning in 2023.
- After quarter-end, the board declared a $0.15-per-share dividend on October 20, 2022. Management reported no material change to previously disclosed risk factors, no material pending litigation, and effective disclosure controls.
Important facts for investors to verify
- Whether rapid commercial real estate loan growth and the 99.22% loan-to-deposit ratio remain manageable as deposits compete and funding costs rise.
- Deposit concentration, uninsured balances, and actual liquidity available after collateral pledges, letters of credit and outstanding FHLB borrowings.
- Credit performance and allowance adequacy, particularly under weaker economic conditions, higher rates, or declining real estate collateral values.
- Potential effect of CECL adoption, elevated securities unrealized losses, and planned subordinated-note redemptions on earnings, capital and liquidity.
- Whether reported earnings comparisons are evaluated on a consistent tax basis, given the 2021 S-to-C corporation transition and deferred-tax adjustment.