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FSB Bancorp, Inc. (NASDAQ:FSBC)
Q2 2021 Earnings Call
Jul 27, 2021, 1:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Welcome to Five Star Bancorp earnings webcast for the second quarter. Please note this call was conferenced, and you're encouraged to listen via webcast. [Operator instructions] Before we get started, let me remind you that today's meeting will include some forward-looking statements within the meaning of applicable security 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 positions.

Such statements involve risks and uncertainties, and future activities and roles may differ materially from these expectations. Among other things [Audio gap]and risk, the ongoing COVID-19 pandemic may significantly affect the banking industry and the company's business prospects. Outlined in there, on the company's business and financial results, will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic, its impact on the economy, the company, customers, and its business partners. The effect in the business and distribution of the COVID-19 vaccines particularly all new variants emerge and actions taken by government authorities in response to the pandemic.

For a more complete discussion of risk and any uncertainties that may cause actual results to differ materially from the company's forward-looking statements, please see the company's quarterly report on Form 10-Q for the quarter ended March 31st, 2021, and in particular, the information set forth in Item 1A risk factors herein. Please refer to Slide 2 of the presentation which includes disclaimers regarding forward-looking statements, industry data, and non-GAAP financial information included in the presentation, as well as reconciliations and to -GAAP financial measures to the most directly comparable GAAP figures. Please note that this event is being recorded, and now I'd like the turn the presentation over to Mr. James Beckwith, Five Star Bancorp president and CEO.

Please go ahead.

James Beckwith -- President and Chief Executive Officer

Thank you for joining us today to review Five Star Bancorp's financial results for the second quarter of 2021. Joining me today is Heather Luck, senior vice president and chief financial officer. Before we discuss earnings, I would like to note that we have included an overview of the company, including our management team mission and other important details in today's presentation materials. We recognize that we have a lot of new investors that they have not seen our roadshow presentation prior to our initial public offering.

So we've included some informational materials at the end of this presentation for your reference. 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 www.fivestarbank.com, and click on the Investor Relations tab. The second quarter of 2021 was a continuation of our organic growth story: loans, deposits, and total assets that's consistently grown quarter over quarter.

Within the loan portfolio, the non-PPP loans grew by 103.2 million or 7.6%, which was primarily within the manufactured home community and multi-family concentrations of the loan portfolio. Approximately 63 million of PPP loans were forgiven during the quarter, and 1.2 million of PDP fees were recognized during the three months ended June 30th, 2021, leaving 121 million of PPP loans outstanding and 3.5 million of deferred fees to be recognized as of June 30, 2021. We anticipate the full balance of all PPP loans will be forgiven by the end of Q1 2022. Our pipeline continues to remain strong at June 30 within existing verticals and we have consistently operated in.

As presented in the loan portfolio and commercial portfolio diversification slides, loan originations excluding PPP loans during Q2 were approximately 178 million which is 44% higher than last quarter; and payoffs, excluding PPP loans, were 76 million which was 29% lower than last quarter. Asset quality continues to remain strong with non-performing loans representing only 0.03% of the portfolio. At June 30, 2021, there were 10 loans totaling 12.9 million in the aggregate on a COVID-19 deferment. We anticipate all borrowers to return to their pre-COVID-19 contractual payment status after their COVID 19 deferments end.

We did not record a provision for loan losses during the quarter, and the ratio of the allowance for loan losses to total loans excluding PPP loans, a non-GAAP measurement that is reconciled in our presentation, was 1.51% at June 30th, 2021. Deposits grew during the quarter by 83.2 million or 4.2% since the first quarter of 2021. Of which, 30 million of the growth related to non-interest-bearing deposits. Non-interest-bearing deposits as a percent of total deposits at June 30, 2021, remain consistent with the prior quarter at 40%.

Additionally, with the completion of the IPO, our capital position is more robust, and we continue to be well-capitalized. Now that I have discussed the balance sheet, I will hand it over to Heather to discuss the results of operations. Heather?

Heather Luck -- Senior Vice President and Chief Financial Officer

Thank you, James, and hello, everyone. Net income for the quarter was 9.8 million, return on average assets was 1.75%, and return on average equity with 24.25%. Average loan yield for Q2 2021 with 4.73%; and average loan yield excluding PPP loans was 4.76%, representing a decline of 11 basis points over the prior quarter. The current low-rate environment has continued to put pressure on loan yield which we have been able to partially offset by our decline in deposit costs, which were 20 basis points for Q2, compared to 24 basis points for Q1.

This is primarily been due to the decline of the local agency investment fund or Laif Rate for a local agency deposit during the quarter. As a result of these factors, our net interest margin was 3.48% for the quarter which included 1.2 million of PPP fees recognized based on the forgiven loan. Now interest income remained relatively consistent for the second quarter with a slight increase in our gain on sale of loans of 0.2 million due to increased premium on SBA loan sales compared to the prior quarter. Included in non-interest expense for the second quarter was 0.7 million in expenses related to corporate organizational matters leading up to the IPO, and 0.8 million in stock compensation expense for non-recurring IPO-related stock grants to certain members of the company's board of directors.

These expenses are presented in the other operating expenses line item of the Consolidated Statements of Income. Our salaries employee benefits expense also increased during the quarter by 0.2 million with the addition of eight new employees throughout the quarter. Since the beginning of the year, we have added five business development officers and six lending support staff which is contributing to our overall robust loan pipeline. We've also increased headcount in our branch operations, compliance, and accounting departments to support the continued growth and additional reporting requirements of the IPO.

We also converted to a C corporation as of May 5th, 2021. As a result, we recognized a $4.6 million benefit for the true-up of a net-deferred tax asset balance at the 29.56% statutory rate which was partially offset by a $2.4 million true-up of the year to date tax provision expense using the effective tax rate of 20.77% which represents the weighted average rate between the 3.5% as corporation tax rate and the 29.56% C corporation tax rate. Weighted for the total number of days, each type of corporation will be in operations during the year. Net income when applying a 29.56% C corporation tax rate would have been $7.4 million for 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 Chief Executive Officer

Thank you, Heather. As we have discussed today, the bank continues to produce consistent earnings, maintain strong capital levels, solid credit quality, and excellent liquidity. We are proud to continue our mission to become the top business bank in all markets we serve. There have been some noteworthy acquisitions in the capital region in 2021 that we have benefited from -- on both the customer and talent acquisition sides.

We are an attractive place for experienced bankers to work and bring energy enthusiasm to our market. Since the beginning of the year, we have added business development officers and supported operational and lending staff. Additionally, we have added two new members to the board of directors. Our pipeline is robust, and we look forward to continuing our great organic growth story in the capital region and the Northern California market.

We appreciate your time today. This concludes today's presentation. Now Heather and I will be happy to take any questions that you may have.

Questions & Answers:


Operator

[Operator instructions] First question comes from Jackie Bohlen, KBW. Please go ahead.

Jackie Bohlen -- KBW -- Analyst

Hi. Good morning, everyone. Just wanting to start off -- hi. Just wanting to start off on growth.

You obviously had tremendous growth in the quarter, one of the fewer banks to post net growth with PPP runoff and then obviously really strong once you exclude those balances. Is it more broad-based across individual categories, or is there one area, in particular, that's showing a lot of strength?

James Beckwith -- President and Chief Executive Officer

During the second quarter, we experienced a fair amount of new production in our mobile home park manufactured home community portfolio. We're very active in the space both in state and out of state in, and I think we had probably around -- was it 60-plus million in originations in that particular vertical. Right behind it is our multifamily originations were also strong. But between those two categories, it made up the bulk of the increases.

But we also remain very active in our faith-based lending or agricultural lending and our small business lending within the capital region. So overall, we expected to see a fair amount of growth in our mobile home park community portfolio. And as we move forward, I think that we're also going to see some steady growth within that particular vertical.

Jackie Bohlen -- KBW -- Analyst

Right. And when you look at the quarter's growth, does it feel more like there may have been some pent-up demands and now that things are more open and I realized that throughout the country openings have been different throughout the pandemic. But did that have an impact on some of the quarters' volume?

James Beckwith -- President and Chief Executive Officer

I think that the biggest impact that we saw particularly in the manufactured home space, the mobile home park space, was that we added new customers. As you may remember, Jackie, we focus on those professional firms that manage and operate several mobile home parks. And we are able to add and expand our relationships within those -- that group. I think right now, we serve 15 of those operators, and we seem to be adding one or two every quarter, so we think that that's more of a function of just our customer base and the fact that we're making a name for ourselves in that vertical throughout the United States.

Jackie Bohlen -- KBW -- Analyst

OK. And, James, I know in the past we talked about the ability of these customers to do some acquisitions from some of the smaller competitors. Are you seeing any changes in those trends that might provide lending opportunities in the future?

James Beckwith -- President and Chief Executive Officer

No. For the most part, all of our customers in the manufactured home space, mobile home park space, are value-add investors. And they're constantly looking for opportunities in which they can come into a park, return it, raise rates, do the necessary capex expenditures, and just improve the quality of the park itself thereby increasing net operating income. So I think that those trends are going to continue.

Now as we understand it, there's 50,000 of these parks in the United States, and only about 20% of them are managed and owned by professional mobile home park operators. So we see our opportunity in that space to be quite robust.

Jackie Bohlen -- KBW -- Analyst

OK. And I guess that that's more where I was getting to is with those owner -- with those operators only owning 20%, are they themselves seeing any sort of a change with kind of one-off parks that might be looking to sell?

James Beckwith -- President and Chief Executive Officer

Yes. The acquisition process by these operators is -- it takes several different forms. They're great in identifying underperforming parts in areas in which they're interested -- geographic areas in which they're interested in. And they'll start a process, i.e., a dialogue with the owners.

And those processes can take a year or two years or a few months, and it's really about identification in terms of those underperforming parks. And our customers are professionals and they have a tried and true playbook of how to do that. And we'd expect them to continue to do that across the United States and certainly here on the West Coast.

Jackie Bohlen -- KBW -- Analyst

OK. Great. Thank you for taking all my questions. I'll step back now.

Operator

Thank you. The next question is from Gary Tenner of D.A. Davidson. Please go ahead.

Gary Tenner -- DA Davidson & Co. -- Analyst

Thanks. Good morning. Just wanted to talk a little bit about kind of the prevailing loan yields on new production. Your core loan yield ex-PPP declined a bit this quarter, which is not that uncommon, of course, given the rate environment.

But maybe talk about where the loans have been coming on the balance sheet in the most recent quarter.

James Beckwith -- President and Chief Executive Officer

Sure. I think if we aggregated all the yields on the production in Q2 -- Heather, I don't know if you have any data on that. I kind of benchmarked it to be right around between 4% and 4.10% in terms of yield which is certainly less than what we have in the portfolio. But that's kind of what we've been seeing as a blended yield of new products going into our portfolio.

Gary Tenner -- DA Davidson & Co. -- Analyst

Thank you. And then just on the other side of the balance sheet, you've done a great job bringing down funding costs in recent quarters, this quarter as well. Is there much more room in any particular deposit category to bring this lower?

James Beckwith -- President and Chief Executive Officer

I think a little bit more room. As Heather mentioned in our formal presentation, the local area investment rate has been coming down. Right now it's at 26 basis points. We expect it to go down probably up to around 20, maybe less than 20, which is going to drive our cost of funds.

Right now, on a run-rate basis, we're -- for the month of July is 10 basis points. So you can see that it's still coming down certainly compared to Q2. Where it bottoms out, it could be from, I don't know, probably 9 to 10 basis points, I'm thinking. Well, that's my -- what my gut is kind of telling me.

And -- which will certainly help us.

Gary Tenner -- DA Davidson & Co. -- Analyst

Yes. And then just last question for me. Obviously, some higher cash balances this quarter between deposit growth and the IPO proceeds as you -- and I think you invested a little bit incrementally in the bond portfolio. So as you think liquidity deployment, balance sheet management, how are you thinking of that at the back half of the year?

James Beckwith -- President and Chief Executive Officer

Well, I certainly was a lot more excited about investing in the bond portfolio when the tenure was at 1.60 as opposed to what it is right now. So we're going to be cautious and prudent about that in terms of growing our bond portfolio and look for those opportunities to invest when rates do move up. We are committed to growing the bond portfolio, but -- and we do expect rates to move up. It's just a question of when.

So we're going to be ratably increasing it certainly in the second half of the year, but nothing -- no major big bets. I think it's probably going to be consistent with the first half of the year, wouldn't you say, Heather?

Heather Luck -- Senior Vice President and Chief Financial Officer

Yes. We really just want to make sure that we're being measured and steady in our investments in the securities portfolio.

James Beckwith -- President and Chief Executive Officer

As you know, we'd much rather put this liquidity in our loan portfolio, and we're excited about where we are from a pipeline perspective. And it's just a matter of closing those deals, and we'll just have to see how the second half of the year goes. But we're excited about where we stand.

Gary Tenner -- DA Davidson & Co. -- Analyst

Great. Thanks for taking my questions.

Operator

Mr. [Inaudible], are you on the line with us?

Unknown speaker

Oh, yeah. Thanks. Good morning. Sorry I was on mute.

Operator

Go ahead with your question.

Unknown speaker

Thank you. Maybe to that last point, James. I think in the past, we've talked about a loan pipeline running at, I don't know, about 150 million to 175 million. I understand growth was very strong this quarter.

Just any update as to the -- where the pipeline stands today relative to kind of prior quarters.

James Beckwith -- President and Chief Executive Officer

Sure. Well, I can tell you specifically. I mean, I look at it every day probably multiple times. So we're right around in terms of initial advance which is probably the best measurement for media to impact, right around 300 million.

Now that's assuming there are -- in terms of the impact of that is assuming that we're going to have 100% pull-through on that and that's never been the case. But we're confident that we're going to have significant originations in Q3. It's just a question of you know sometimes deals fall out for whatever reason, but it's certainly higher than what it was, let's say, when we entered Q2 and we're excited about that. Now I do want to mention that we did add five BDOs.

So we've got some new talent that's coming in. We've got -- we took somebody from Wells Fargo; California Bank & Trust; Mechanics Bank; Bank of the West; and our friends downstairs on the fourth floor, American River Bank. So we're hoping for them to make an immediate impact, and so far so good. And then, of course, our veterans that have been around here a long time are having great years, so we're excited about where we stand from a pipeline and new origination perspective.

Unknown speaker

All right. Great. That's excellent color. And just to clarify, the five BDOs that was were added, is that part of the eight full-time employees that were added throughout the past quarter?

James Beckwith -- President and Chief Executive Officer

Correct.

Unknown speaker

OK. Thank you. Maybe on fee income just quickly. It's a nice quarter from SBA.

Just on the SBA sale front, you're running at about 10 to $11 million of loans sold per quarter. Is that gonna be a fairly consistent kind of for-sale run rate moving forward? And then any kind of expectations for SBA gain-on-sale margins over the next couple of quarters?

James Beckwith -- President and Chief Executive Officer

Sure. That business is off historically from what it was previous years. I think it certainly had -- it's been impacted by the PPP loan process and the idle loans which are very attract -- the auto loans are very attractive credits to folks. So you -- we've -- we expect that business to be steady but not spectacular.

And what's happened with less volume, the premiums that we're receiving have made up for that less volume as we're moving forward. So I think it could be probably pretty consistent with that -- those types of levels given if premiums hang in there. Now we're getting paid 116 in change on on our originations which is pretty significant. Now that does not all net down to the bottom line.

We have to split. We've got a lot of marketing costs associated with that. We've got to split 50% of anything greater than 110 with the SBA, and then we do our basis allocation and servicing strip valuation accounting. So if -- but it's historically at its highest levels that I've seen for that 10-year paper.

Heather Luck -- Senior Vice President and Chief Financial Officer

Yes. Just to add a little color, we included it in the earnings release. So premiums -- net premiums received were 9.82 this quarter, compared to 7.91 last quarter. So there is an uptick in the premiums that we're receiving.

Unknown speaker

But fair to say maybe that as gain-on-sale margins kind of normalize, there might be a step up in production as well that would offset part of that?

James Beckwith -- President and Chief Executive Officer

We sure hope so. There's going to be a mad rush for people to get into SBA in Q3 because at September 30th, the rules change and I don't think they're going to be extended, the rules being a 90% guarantee and no guaranteed fees happen to be paid by the customer. And those are significant matters so we hope this will spur some people forward in terms of getting an SBA seven-day loan, and only time will tell.

Unknown speaker

All right. Great. Thank you. And then just one last one for me.

The reserve level stayed pretty stable around 140 even after no provision this quarter just given the growth. Any thoughts on how the reserve and kind of provision trends over the next few quarters?

James Beckwith -- President and Chief Executive Officer

Well, asset quality remains very very good. We certainly evaluate it on a quarterly basis. And I think that as we look at our qualitative reserves every quarter, we look at what was set aside at 12/31 with respect to the SBA portfolio and make determinations about that. And we'll just have to see how that portfolio performs over this next quarter, but we're very comfortable with it -- where it is right now.

Heather?

Heather Luck -- Senior Vice President and Chief Financial Officer

Yes. And on that note, for the qualitative reserve, we kind of think a viewpoint that we're not out of the woods yet with COVID. Delta variant is picking up, and we just don't know where are our small business loans are going to sit at the end of the year. So we were kind of waiting to vote out and have six months of payments before we even start to consider releasing or reducing the reserve factor.

We don't release reserve but reduce the reserve factor. Yes.

Unknown speaker

OK. Well, I appreciate you taking my questions, and congrats on a good quarter.

James Beckwith -- President and Chief Executive Officer

Thanks so much.

Operator

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

James Beckwith -- President and Chief Executive Officer

Great. Thank you. I want to thank everybody for joining us this quarter. Today's presentation demonstrated at Five Star Bank is continuing on a path of robust organic growth.

We are attracting and retaining talent while preserving a culture driven by speed to serve and certainty of execution. Importantly, our customers trust us and they have direct access to us at all times. This is a key differentiator in our market and a driver of customer acquisition as evidenced by the strength of our growing pipeline. Purpose- and integrity-driven banking are foundational to who we are.

We will continue to build meaningful relationships and serve our shareholders, customers, employees, and community. Please contact me or Heather if you have any questions. We look forward to speaking to you again in October for our third-quarter 2021 earnings call. Have a great day, and thank you for listening.

Operator

[Operator signoff]

Duration: 29 minutes

Call participants:

James Beckwith -- President and Chief Executive Officer

Heather Luck -- Senior Vice President and Chief Financial Officer

Jackie Bohlen -- KBW -- Analyst

Gary Tenner -- DA Davidson & Co. -- Analyst

Unknown speaker

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