FSB Bancorp, Inc. (FSBC) Q3 2021 Earnings Call Transcript

FSB Bancorp, Inc. (FSBC -0.14%)
Q3 2021 Earnings Call
Oct 26, 2021, 1:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Hello. Welcome to the Five Star Bancorp third-quarter earnings 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 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. Among other risks, the ongoing COVID-19 pandemic may significantly affect the banking industry and the company's business prospects. The ultimate impact 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 companies customers and its business partners, the effectiveness and distribution of COVID-19 vaccines particularly as new variants emerge and actions taken by government authorities in response to the pandemic. 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 quarterly report on Form 10-Q for the quarter ended June 30, 2021, and in particular, the information set forth in Item 1A risk factors therein.

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 as well as reconciliations to non-GAAP financial measures to their most directly comparable GAAP figures. This conference call is being recorded. I would now like to turn the presentation over to 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 third quarter of 2021. 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 www.fivestarbank.com, and click on the Investor Relations tab.

In the Company Overview section, we have provided a brief overview of our geographic footprint, our executive management team, as well as our consistent organic growth over the last 10 years. The third quarter of 2021 exhibited continuing execution of our organic growth strategy following our IPO in May as evidenced by our earnings expense management and increases in headcount during the quarter. Additionally, loans deposits, and total assets have consistently grown since the previous quarter. Within the loan portfolio, non-PPP loans grew during the quarter by 181.6 million or 12.4%, which was primarily within the manufactured home community and multi-family concentrations of the loan portfolio.

Approximately 59 million of PPP loans were forgiven during the quarter and 1.8 million of PPP fees were recognized during the three months ended September 30th, 2021, leaving 61.5 million of PPP loans outstanding and 1.7 million of deferred rate -- deferred fees to be recognized. We anticipate the full balance of PPP loans to be forgiven by the end of Q1 2022. Our pipeline continues to remain strong at September 30th within the verticals we have historically operated in as presented in the loan portfolio diversification slide. Loan originations excluding PPP during Q3 were approximately 280 million, which is 55% higher than the last quarter.

And payoffs excluding PPP loans were 101 million which was 33% higher than the last quarter. Asset quality continues to remain strong with non-performing loans representing only .03% of the portfolio consistent with the last several quarters. At September 30th, 2021, there were eight loans totaling 12.2 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 deferment ends.

At September 30th, 2021, the allowance for loan losses totaled 21.8 million. We did not record a provision for loan loss 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 press release, was 1.33% at September 30th, 2021. Given our anticipated growth rate in the fourth quarter, loan growth rate in the fourth quarter, we expect to record a provision for loan losses. Loans designated at substandard totaled 36.8 million at September 30th, 2021, representing a slight increase from the previous quarter.

This did not have an impact to the allowance overall, and there were no loans designated as doubtful at the end of the third quarter. Deposits grew during the quarter by 102.1 million or 4.9% since the second quarter of 2021, of which, 66 million of the growth related to non-interest-bearing deposits. Non-interest bearing deposits as a percent of total deposits at September 30th, 2021, increased slightly to 41% as compared to 40% in the prior quarter. We have had strong deposit growth over the last several quarters from the previous years and through the current quarter.

Total cost of funds included -- including our subordinated debt was 17 basis points during the quarter. Finally, we continue to be well-capitalized with all capital ratios well above regulatory thresholds for the quarter. Now that we 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 11 million, return on average assets was 1.85%, and return on average equity was 19.26%. Average loan yield for Q3 2021 was 4.90%; and average loan yield excluding PPP loans, a non-GAAP measure that is reconciled in our presentation, was 4.66%, representing a decline of 10 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 cost of funds, which were 17 basis points for Q3, compared to 20 basis points for Q2.

As a result of these factors, our net interest margin was 3.60% for the quarter which included 1.8 million of PPP fees recognized based on the forgiven loan. Now interest income increased to 2.0 million in the third quarter from 1.8 million in the previous quarter, primarily as a result of increased gains on sale -- gains on the sale of available for sale securities. Non-interest expense declined to 8.6 million in the third quarter from 9.6 million in the previous quarter as the second quarter's non-interest expense included 0.7 million in expenses related to corporate organizational matters leading up to the company's 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, neither of which recurred in the third 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 basis.

We are an attractive place for experienced bankers to work and bring energy enthusiasm. Since the beginning of the year, we have added business development officers and supporting operational and lending staff. Additionally, we have added three new members to the board of directors. Our pipeline is robust, and we look forward to continuing our 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 might have.

Questions & Answers:

Operator

[Operator instructions] The first question comes from Andrew Terrell with Stephens. Please go ahead.

Andrew Terrell -- Stephens Inc. -- Analyst

Hey. Good morning, James. Good morning, Heather.

James Beckwith -- President and Chief Executive Officer

Good morning.

Heather Luck -- Senior Vice President and Chief Financial Officer

Good morning.

Andrew Terrell -- Stephens Inc. -- Analyst

Hey. So excellent quarter from a loan growth perspective. James, I just wanted to go back to some of your comments in the prepared remarks about the fourth-quarter growth. Do you think you can replicate a similar quarter in 4Q in terms of new loan originations? And then just to tack onto that, could you size up where the loan pipeline is at today relative to growth at the prior quarters?

James Beckwith -- President and Chief Executive Officer

Sure. The pipeline has been pretty consistent in terms of what we're facing and in terms of potential funding. So our pipeline -- our initial advanced pipeline, which is the metric that I look at all the time, is -- it's about $330 million right now as we speak. Now we're not going to get -- to get a hundred percent fundings on all that would be probably not going to happen but we're looking for maybe 80 to 90%of that.

So we expect to be able to deliver similar growth in terms of dollars in the fourth quarter in terms of the loan portfolio. So I think we feel pretty good about Q4 as it relates to loan growth. We still have a lot of liquidity that would provide the funding for these originations, and so we're excited about moving into the fourth quarter from a loan growth perspective.

Andrew Terrell -- Stephens Inc. -- Analyst

Right. I appreciate it. And is the biggest driver just kind of the step-up in production that we saw this quarter? Is it really just new talent that's been added to the bank? And in kind of longer term, do you think this level of production is kind of sustainable?

James Beckwith -- President and Chief Executive Officer

Yeah. I think it's two things. Certainly, the new talent that we brought on, they're moving the needle. We brought on five new biz dev people from the beginning of the year, Andrew.

One of them didn't work out, but the four that did are doing pretty well. So we're excited about that. You can't always bad a thousand. But also the verticals in which we're in and the professionals that are -- fundamentally serve as the front end of this dev side of those verticals are doing extremely well.

Our mobile home community opportunity is very robust. Our faith-based opportunity is very robust. We're excited about that. I will comment a little bit about SBA.

You didn't ask this Andrew, but I think it's important to note that we sense the premiums in that market are declining. And so it's a question of how much -- by how much. So we think that that's going to have some impact with respect to our gain on sale numbers. But we're building out that function trying to attract business development people that are solely dedicated to SBA originations.

Not a lot of visibility on it right now, Andrew, so nothing really to report other than a positive intention on our behalf. But I think what we have in place in terms of business development folks and lenders and what we've added in 2021 I think were all -- they're all hitting their stride right now.

Andrew Terrell -- Stephens Inc. -- Analyst

Right. OK. That's helpful color. I appreciate it.

I think you're -- Five Star was probably one of the few banks that was able to actually leverage the loan to deposit ratio at this quarter. Can you just remind us where you're generally comfortable with managing the loan to deposit ratio? And kind of taking some of your comments around growth into consideration, how quickly you think you might be able to get there.

James Beckwith -- President and Chief Executive Officer

Sure. It's a -- I think that we like operating between 90 and 95, Andrew. Provided that we've got a significant amount of backup liquidity that we can tap into, as we sit here today, we do. That's off-balance-sheet liquidity.

You know we don't fund are our loan portfolio with Internet CDs or broker deposits all -- it's all core. So we want to make sure that we maintain strong backup liquidity and trying to push up our loan to deposit ratio to those particular levels. So I think if we can do that, the result and the impact on net interest income and the bottom line wre going to I think attractive to our investors and to our shareholders.

Andrew Terrell -- Stephens Inc. -- Analyst

OK. Maybe just one more for me. Just as we start thinking about potential kind of rate hikes maybe later next year into 2023, can you remind us what your leverage is to a 25, 50, 75 basis-point increasing -- in short-term rates?

James Beckwith -- President and Chief Executive Officer

Sure. Heather, do you have some information on that?

Heather Luck -- Senior Vice President and Chief Financial Officer

Whenever we look at our stress testing and our yield curve shot, typically in our -- our rate's up a hundred basis points for about 3.2 to 3%. Now that also includes about 500 million of cash that's sitting at that earning 10 basis points right now. So as we continue to fund loans, that will improve our shock scenario.

James Beckwith -- President and Chief Executive Officer

Yeah. I think that it's really going to be a function of what rates do we bring on new production at, Andrew, and also to the extent that we can continue to grow our non-interest-bearing deposit base, which I think we're pretty excited about our opportunities there. So I think we're positioned to perform better in a rising-rate environment as we sit here today, and so we'll just have to see how things unfurl with respect to that.

Andrew Terrell -- Stephens Inc. -- Analyst

OK. Maybe if I could just fire one more in on kind of the current cash position. Is it fair to think with kind of the growth outlook currently that the excess liquidity has kind of worked in the loan portfolio over time rather than used to kind of build securities portfolio? And then can you just remind us where you're comfortable running the cash position at?

James Beckwith -- President and Chief Executive Officer

Yeah I think that we're fairly active with respect to the investment portfolio. I think that it's a place that if you looked at us right now, investment portfolio divided by total assets, you can see that we're probably a third or close maybe pushing a half to -- with our peers. Their investment portfolios are. We'd rather place our liquidity into the loan portfolio.

So we're not looking to be very aggressive at all in terms of making those investment securities purchases. We think that we're gonna be better off making loans from a net margin perspective, given I think our credit metrics, the types of deals we look at, which we think are very safe and secure. So, yeah, I'm not -- in terms of prospects for growth in the -- of the securities portfolio, Heather, I don't think that that's not where we're leaning to at all.

Heather Luck -- Senior Vice President and Chief Financial Officer

No. No.

Andrew Terrell -- Stephens Inc. -- Analyst

OK. Perfect. Great quarter, and thanks for taking my questions.

James Beckwith -- President and Chief Executive Officer

Thank you, Andrew.

Heather Luck -- Senior Vice President and Chief Financial Officer

Thank you, Andrew

Operator

[Operator instructions] We do have a question from Gary Tenner. Please go ahead with your question.

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

Good morning. Some of my questions were answered. But just to clarify a couple of items. In terms of the tax rate, would the tax rate from this quarter be the same in fourth quarter before that normalizes in 2022? Is that going to be --

Heather Luck -- Senior Vice President and Chief Financial Officer

Yeah. We'll -- Yes. So we're applying -- it's a blended rate between the number of days outstanding for S Corp and C Corp for the years that we'll be using a 20.77% blended rate applied to our taxable income estimate for the year. Yeah.

The tax revision has been noisy this year just given all the activity, but that would be the rate we'll use.

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

OK. And then I should have hopped in a minute too late, so I apologize if you went through this. But in terms of deposit costs, any remaining room there? I know last quarter it seemed like you're getting close in terms of the bottom on interest-bearing deposit costs but your money market and time accounts moved down a little bit more this quarter. So are we pretty much there in terms of interest-bearing costs at this point?

James Beckwith -- President and Chief Executive Officer

Yes. And just looking at our -- just our deposit costs with, Heather, 9 basis points and we think that that's probably going to be tough to move downward. So we think that we're probably done with this run in terms of our funding costs as it relates to our deposit base. So 9 basis points is probably where it's [Inaudible].

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

OK. And then on the loan side with a 10 basis point decline in the core loan yield, what was the yield on new production this quarter?

James Beckwith -- President and Chief Executive Officer

Heather, you got that --

Heather Luck -- Senior Vice President and Chief Financial Officer

Yeah. So the yields our new production. The weighted average rate was about 4.32%. And then, obviously, our largest category within our multifamily which continues [Inaudible] multifamily lending.

And that was 4.01% weighted.

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

I'm sorry. Four point --

Heather Luck -- Senior Vice President and Chief Financial Officer

4.01.

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

4.01? OK. OK. That's all I have. Thank you.

James Beckwith -- President and Chief Executive Officer

Thank you.

Heather Luck -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

And we have a follow-up from Andrew Terrell with Stephens. Please go ahead.

Andrew Terrell -- Stephens Inc. -- Analyst

Hey. Thanks for taking the follow-up. I wanted to ask. I think there are about $12 million of loans that are still in deferral.

Are these concentrated within one specific industry? Are they interest only or full deferrals? And then any kind of timeline to resolution here? Any color on just the remaining deferrals would be helpful.

Heather Luck -- Senior Vice President and Chief Financial Officer

Sire. So we -- they are all currently on an interest-only deferral. They hit really two categories, but the largest one is in our CRE Special Purpose. It's a theater that is on deferral right now.

I believe that they're working on getting a grant.

James Beckwith -- President and Chief Executive Officer

Yes. They've already received a grant. This is a performing arts, Andrew, a performing arts building in midtown Sacramento. The organization's been around for -- pushing 30 years.

It's great sponsorship. They're just coming back online right now in terms of having events and having performances. So that's creating some momentum. But we think that they're gonna be fine from a financial perspective.

And when they come off deferral, they'll go to full payment once again. But that makes up almost all of it.

Heather Luck -- Senior Vice President and Chief Financial Officer

All of it.

James Beckwith -- President and Chief Executive Officer

Yeah. That one relationship.

Heather Luck -- Senior Vice President and Chief Financial Officer

The remainder of the loan in that balance are SBA.

James Beckwith -- President and Chief Executive Officer

Yeah.

Andrew Terrell -- Stephens Inc. -- Analyst

Got it. Thank you. And then on SBA, do you have how much in SBA loan sales over this quarter? I might have missed it on the release.

James Beckwith -- President and Chief Executive Officer

In terms of gain?

Andrew Terrell -- Stephens Inc. -- Analyst

I've got the gain on sale number, but just the dollar of SBA loans that were sold.

Heather Luck -- Senior Vice President and Chief Financial Officer

That will be -- we'll have that in the cash flow in the 10-Q.

Andrew Terrell -- Stephens Inc. -- Analyst

OK.

James Beckwith -- President and Chief Executive Officer

I could probably tell you it's around 15 million, 16 million.

Andrew Terrell -- Stephens Inc. -- Analyst

OK. Perfect. I'll look for it in the Q as well.

James Beckwith -- President and Chief Executive Officer

Yeah.

Andrew Terrell -- Stephens Inc. -- Analyst

Thanks for taking the follow-up.

James Beckwith -- President and Chief Executive Officer

Sure.

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 Chief Executive Officer

Great thank you. I want to thank everybody for joining us this quarter. Today's presentation demonstrated that Five Star Bancorp 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 all -- 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 as we serve our shareholders, customers, employees, and community.

Please contact me or Heather if you have any questions. We look forward to speaking with you again in January to discuss earnings for the three and 12 months period ended December 31, 2021. Have a great day, and thank you for listening.

Operator

[Operator signoff]

Duration: 27 minutes

Call participants:

James Beckwith -- President and Chief Executive Officer

Heather Luck -- Senior Vice President and Chief Financial Officer

Andrew Terrell -- Stephens Inc. -- Analyst

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

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