Welcome to the Five Star Bancorp Q4 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. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then 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, 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 company's customers and its business partners, the effectiveness 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 September 30, 2021. In particular, the information set forth in Item 1A, Risk Factors therein.
Please refer to slide two of the presentation, which include 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, which is included in the appendix to the presentation. Please note this event is being recorded. I'd now like to turn the presentation over to James Beckwith, Five Star Bancorp President and CEO. Please go ahead.
Thank you for joining us to review Five Star Bancorp's financial results for the fourth quarter and year ended December 31, 2021. Joining me today is Heather Luck, Executive 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. In the company overview section, we have provided a brief overview of our geographic footprint and our executive management team. The fourth quarter of 2021 exhibited continued execution of our organic growth strategy following our IPO in May, as evidenced by our earnings, expense management, and balance sheet trends during the quarter. Additionally, loans, deposits, and total assets have consistently grown since the previous quarter and year-over-year.
Our pipeline continues to remain substantial at the end of 2021 within the verticals we have historically operated in, as presented in the loan portfolio diversification slide. Non-PPP loans, a non-GAAP measurement that is reconciled in our press release, grew during the quarter by $274.5 million or 16.7%, primarily within the manufactured home community, CRE retail, CRE industrial concentrations of the loan portfolio. Non-PPP loans grew by $563 million or 41.4% year-over-year, primarily in the manufactured home community, multifamily, CRE retail, and CRE industrial concentrations of the loan portfolio.
Approximately $39 million of PPP loans were forgiven during the quarter, and $1.1 million of PPP fees and interest were recognized during the fourth quarter of 2021, leaving $22.1 million of PPP loans outstanding and $0.6 million of deferred fees to be recognized at year-end. For 2021, approximately $236 million of PPP loans were forgiven and $6.2 million of PPP fees and interest were recognized. We anticipate the full balance of PPP loans to be forgiven in the near term. Loan originations excluding PPP loans during Q4 were approximately $462 million, which is 65% higher than last quarter, and payoffs excluding PPP loans were $194 million, which was 87% higher than last quarter.
Approximately $39 million of loans paid off in the Q4 were risk rated as watch or classified. During 2021, loan originations excluding PPP loans were approximately $1.0 billion, and payoffs excluding PPP loans were $479 million. Asset quality continues to remain strong, with non-performing loans representing only 0.03% of the portfolio, consistent with the last several quarters. At year-end, there were six loans totaling $12.2 million in aggregate on the COVID-19 deferment program. We anticipate all borrowers to return to their pre-COVID-19 contractual payment status after their COVID-19 deferments end. At the end of 2021, the allowance for loan losses totaled $23.2 million. We recorded a $1.5 million provision for loan losses during the Q4 for a total provision for loan losses of $1.7 million for the year.
The ratio of the allowance for loan losses to total loans, excluding PPP loans, a non-GAAP measure that is reconciled in our press release, was 1.21% at year-end. Loans designated at Watch and Substandard totaled $8.6 million and $10.6 million, respectively, at the end of 2021, representing a decrease of approximately $12.5 million and $26.2 million, respectively, from the previous quarter, and $15.6 million and $25.2 million, respectively, from the previous year-end. This reduced our reserves related to classified and watched loans by half a million dollars, which was offset by additional provisions for loan growth during the 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 Q4 , deposits grew by $117.5 million or 5.4% as compared to the Q3 of 2021. During 2021, deposits grew by $501.9 million or 28.1% since the end of 2020, of which $201 million of the growth related to non-interest-bearing deposits. Non-interest-bearing deposits as a percent of total deposits for the Q4 decreased to 39.5% from 41.5% in the Q3 , but increased to 39.5% from 39.3% for 2021 when compared to 2020. We have had strong deposit growth over the last several quarters and through the current quarter. Cost of total deposits was 8 basis points during the Q4 .
We continue to be well-capitalized with all capital ratios well above regulatory thresholds for the quarter and the year. Net income for the quarter was $11.3 million. Return on average assets was 1.82%, and return on average equity was 19.15%. Net income for the year was $42.4 million, with return on average assets and return on average equity of 1.86% and 22.49%, respectively. Average loan yields for Q4 2021 was 4.71%, and average loan yields excluding PPP loans, a non-GAAP measure that's reconciled in our presentation, was 4.56%, representing a decline of 10 basis points over the prior quarter and 38 basis points over the prior year.
The current low-rate environment has continued to put pressure on loan yields, which we have been able to partially offset by our decline in cost of funds, which was 16 basis points for Q4 and 19 basis points for 2021, compared to 17 basis points for Q3 and 54 basis points for 2020. As a result of these factors, our net interest margin was 3.67% for the quarter, which included $1.1 million of PPP fees and interest recognized based on forgiven loans, while net interest margin for 2021 was 3.64%, which included $6.2 million of PPP fees and interest recognized based on forgiven loans.
Non-interest income decreased to $1.8 million in the fourth quarter from $2 million in the previous quarter, due primarily to a decrease in the gain on the sale of securities from lower volumes sold. Non-interest income decreased to $7.3 million for 2021 from $9.3 million in the previous year, primarily as a result of a decline in loan-related fees, driven by a decrease in swap referral fees recognized in 2021 as compared to 2020. Non-interest expense increased to $9 million in the Q4 from $8.6 million in the previous quarter, driven largely by increased salaries and employee benefits and an increase in various other operating expenses, offset by a decrease in loan-related expenses as Q3 included a $200,000 accrual for an SBA matter in the normal course of business. This did not recur in Q4.
Non-interest expense increased to $36.0 million in 2021 from $28.3 million in 2020, primarily due to increases in salaries and employee benefits and increased commissions due to loan and deposit growth, as well as increased professional services for matters related to our IPO. Now that we've discussed the overall results of operations, I'll now hand it back to James to provide some closing remarks.
Thank you, Heather. 2021 was a remarkable year of growth, renewed purpose, and commitment to our customers, employees, shareholders, and the communities we serve. Most banks offer similar, if not same, products. However, no other bank has our engaged team, our speed to serve, or our certainty of execution. No other bank has our commitment to treating customers with empathetic spirit, understanding, and care. We are proud to have earned the trust of those we serve. This trust has made Five Star Bank an exceptionally attractive organization for business development officers and supporting operational and lending staff to work, engage, and experience their own success. 2021 was an exciting year as evidenced by a robust pipeline, record growth in loans and deposits, new expanded product offerings, new technology, and the build-out of our verticals, all of which are enhanced by a deep sense of shared purpose.
We look forward to our continued organic growth story in the capital region and 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.
We will now begin the question-and-answer session. To ask a question, those dialed in may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Our first question comes from Woody Lay from KBW. Please go ahead.
Hey, James and Heather. How are you guys doing?
Hey, Woody. How are you?
Hi, Woody.
Doing well. Thought we could just start off on the growth outlook. You know, this quarter was exceptional and, you know, full year growth ended at 44%. You know, tough to imagine you guys can repeat that next year. You know, trying to get a better feel for where current pipeline is standing right now and maybe what your initial expectation for year-over-year growth in 2022 looks like.
Sure. Thanks, Stuart. Certainly 2021 was an exceptional year, and it'd be a bit difficult to replicate that. We remain optimistic as we roll into 2022. I think our outlook is, as we sit here today, low double-digit growth for both loans and deposits. Having said that, I think we'll have a lot more visibility on those numbers, Stuart, at the end of the first quarter. In terms of where we're heading, you know, we have attempted, and I think I shared this on the last call, to really, from an earnings perspective and from a balance sheet growth perspective, to deal with a couple matters.
One, the decreased revenue recognition on PPP loans has a negative impact on earnings and also an income tax provision, which we're getting comfortable with as we roll into 2022. We're trying to overcome those two aspects of the earnings drag through loan growth. We think that we've made great strides in that area. I think we'll have a lot more visibility in terms of where we stand on that matter by the end of the first quarter, and then also a better sense of where we think the rest of the year's going. You know, there's some uncertainty out there with respect to you know what the Fed may do and its impact on interest rates.
We have a sense that this is really gonna be a short end of the curve matter, maybe not so much in the long end of the curve. Certainly, we'll see how that works out. We're prepared, and I think we can benefit from those increases on the short end of the curve. I think I was responsive, but is that responsive to your question?
No, that's, yeah, very helpful. I guess kind of pivoting, you know, on your remarks with the Fed, Heather, I mean, how are you thinking about, you know, asset sensitivity, for you guys? I mean, I think if I look into your disclosures, about 78% of your earning asset base is variable rate. Then, you know, last cycle, it looks like interest-bearing deposit costs peaked, right around 120 basis points. You know, any kind of color on, you know, your asset sensitivity and how quickly, we should see your loan portfolio reprice higher if we do get, you know, a Fed hike here in March?
Sure. Yeah. You know, we are asset sensitive. You know, we've got a sizable cash position. We've got about $425 million as of the end of the year sitting, you know, that'll be repriced immediately. For 2022 and 2023, you know, we've got about $67 million of loans that are tied to the five-year Treasury that are set to reprice in 2022 and $79 million that are set to reprice in 2023. We definitely estimate that, you know, we'll benefit from a rising rate environment, probably to the tune of about $75,000 a month, depending on the timing on when the Fed raises interest rates.
You know, total within all of the loans that are gonna reprice over the next two years, we really only need about a 20-25 basis point increase to get those loans off their floors. We'll be in good position for any sequential rate hikes after that.
Heather, that $75 a month is really kind of tied into a 25 basis point move.
Mm-hmm.
There's more moves than that, Woody Lay. You know, you can see the resulting impact. When the Fed continues to move, we'll have those loans come off their floors, which could be pretty favorable for us. We like where we are. With respect to a Fed move or Fed moves, we're not sure how many there's gonna be. I heard the other day, BofA Securities said there's gonna be seven over the next two years. I think there's a lot of a wide degree of opinion, if you will, with respect to what the Fed might do.
Okay. Just kind of a follow-up there. Would you be able to quantify, you know, what portion of your portfolio would reprice, you know, after one hike? Then, you know, what percentage of the portfolios, you know, would reprice if we do get, you know, say, a 50 basis point hike in March? Or I guess after the next one.
Well, this is, you know, to be as accurate as we can, we've got about $110 million book of swaps that are tied to LIBOR that they're gonna move immediately. One-month LIBOR, so we're gonna see that impact and probably, I'm gonna say $60 million-$70 million of prime-based loans that are gonna move. Then, of course, our cash position. If you aggregate all that up, I think you can see the impact.
Great.
The next 25 basis points move will probably affect the rest of the prime-based loans.
Yeah. The loans that are tied to the five-year Treasury, about $45 million will reprice between Q2 and Q3. You know, we've got a small portion that'll reprice in the first quarter, $9.3 million. The bulk of it will be Q2 and Q3.
Tying that all together, you know, I think the core margin saw some nice expansion this quarter. Really, you know, you did not build out your securities book. It really just came from, you know, the tremendous loan growth. How are you thinking about, you know, your core margin progressing throughout 2022? Ultimately, you know, how many hikes do you have, you know, baked in your kind of baseline budget right now? Do you know, maybe quantify the upside if we do get, you know, say, 4-6 hikes this year?
Well, that could be very beneficial to us. This is a very high-level thinking on this in terms of what the numbers may show. If you've got in the neighborhood of $600 million worth of assets that are gonna reprice, $600 million-$700 million of assets repricing, you can do the math. On the liability side, we probably will expect to see some creep in our cost of funds. Certainly, you know, that's always a tricky matter too. We do have a pretty significant government book, about $400 million, which is tied to LAIF, which could start to creep up, although it's a lagging index.
If you can think, every quarter point move is, you know, $75,000 a month, Woody, you can do the math.
Great. Sorry, maybe just one more from me. You know, kind of a core expense growth outlook. You know, this year, you know, backing out the IPO expenses and you know, some other one-time comp, you were at about a 20% annualized growth rate. How are you thinking about, you know, core expense growth rate in 2022 if we do see, you know, pretty strong double-digit loan growth and as well as, you know, just traditional expense inflation, you know, given the competitive environment right now?
You know, yeah, we definitely had some noise in 2020 with the IPO and other initiatives. You know, we really do have our infrastructure for the most part is in place from a personnel perspective, from a you know, technology perspective. We do have some new initiatives for 2022 for build-out. You know, we ended the year. If you look at our non-interest expense as a percent of assets, we ended up at, like, 1.42%. We are really projecting in our budget to remain within that kind of 1.42%-1.45% range. Hopefully that'll help give you all some guidance on the non-interest expenses.
Yep. Stuart, we don't have any major hiring initiatives right now in terms of building out any units or lifts from anybody else. We've got a pretty solid team in place. We intuitively know that we've got a fair amount of operating leverage as we continue to add earning assets. I think that's a good estimate at this point. Again, after you know, 2021 was a you know, a great year, but also a pretty noisy year from a financial reporting perspective. I think that after Q1, you'll see our numbers be a lot more visible, and that will be the first quarter under full C corp status.
Awesome. Well, thank you for taking my questions today. I will hop back in the queue.
Thank you, Woody Lay.
Our next question comes from Andrew Terrell from Stephens. Please go ahead.
Hey, James. Hey, Heather.
Hey. Hey, Andrew.
Hi, Andrew.
Hey, James, I apologize if I missed this, but could you maybe size up just where the pipeline for new loans stood kind of heading into the first quarter? I think it was about $330 million, if I recall, heading into 4Q.
Yeah. We're slightly down from that, as we sit here today. But I think our sense that it's growing. The fourth quarter was exceptional. But it still remains very substantial. You know, so far, as we sit here today, January's a pretty good month. We expect, given how deeply penetrated in the market we are with all of our verticals, that we're gonna have every opportunity to continue to perform well on new loan production. We're guiding right now, you know, certainly less than 40% you know, year-over-year growth. You know, we think that I'm optimistic about, you know, our opportunities that we have in 2021.
I would say, to answer your question specifically, I think we're just slightly down from that pipeline beginning Q4.
Okay. Very good. Thank you. Maybe just thinking about the constituents of what will drive the net growth in 2022. I think manufactured housing is around 27% of the loan portfolio today. Can you just remind us, I guess, the internal kind of cap, if any, you place on that portfolio as a percentage of total loans? Should we expect that to be kind of less of a growth driver moving forward, just in terms of absolute dollars?
Sure. You know, in our concentration methodology, it's all limited by the amount of capital we have, and we assign certain percentages to, you know, various, asset classes in terms of how much we have. We still have a little room to go with respect to our manufactured home communities. We're starting to see other opportunities rise right now in the portfolio, on the multifamily side, which we're excited about, and from the industrial CRE side, and from the faith-based side in particular. We hope that everybody grows at the same rate and in the same dollars. You know, sometimes, one vertical gets out in front of the other. All those markets are very strong right now.
I think the manufactured home community is probably the strongest and from a demand perspective. It's a great asset class. We like it, and we'll continue to monitor it from a credit quality perspective. I don't see any constraints with respect to any of our verticals right now, Andrew, in terms of pulling the reins back in.
Okay. Very good. I appreciate it. Maybe just on SBA gain on sale income. I saw the note in the release that maybe it was a little bit lighter because of some actions with the SBA this quarter. Should we anticipate the dollar amount of loans sold kind of steps up from here? Any reason to think you couldn't get back to the, I think in 2019 and 2020, you were doing about $17 million or $18 million of loan sales per quarter. Just any kind of updated expectations on just SBA volume and maybe gain on sale margin as well, going into 2022?
Sure. It's probably the most difficult vertical to predict in terms of volume and revenue. We're hoping towards the Q3 and Q4, we'll get back to those particular levels of volume. You know, our bread and butter was doing the 350,000 or less 7-, 8-, 10-year equipment loans. That market just really hasn't come back yet. Despite all efforts, I think that the PPP loan process and the EIDL loan process has really presented other opportunities for those borrowers that were traditionally looking at those types of credits or that type of funding. I think that hangover, if you will, from that type of lending, the PPP loans and also the EIDL loans is gonna take a while to work through.
We've reduced our expectations with respect to what we expect to see. If we do see it'll be a nice surprise. You know, in terms of getting back to where we once were, we're all hopeful we'll be able to get back to that level, but in the latter half of the year.
Okay. Very good. Heather, just a housekeeping question, just given some of the noise on the tax rate. Do you have a good kind of expected tax rate we should be using for 2022?
I do, yes. That was another noisy piece of the income statement this year. No. Our statutory tax rate is 29.56%. However, if you consider the benefits for like our tax-exempt income, things like that, we're estimating about 29.26% for the year.
Okay. Perfect. I'll step back in the queue. Thank you for taking the questions and congrats on a great quarter.
Thank you.
Thank you. Thank you, Andrew.
Our next question comes from Gary Tenner from D.A. Davidson. Please go ahead.
Thanks. Good morning. A couple of questions. Wanted to just ask about kind of the loan deposit ratio. You know, it dipped under 80% first few quarters of this year, and then this fourth quarter with the combination of strong loan growth and more moderate deposit growth back up into the mid-80s. Just curious, if you could remind us where you kind of like to optimal level to optimally manage the balance sheet to from that perspective.
Given our capital position, which is enabling us to maybe push that number a little bit, you know, we could operate between 90% and 95%, and that would probably be optimal from an earnings perspective. We'll see how that goes. That provides some upside in terms of margin and also net interest income for us.
In terms of this fourth quarter, you know, core loan yield was down a little bit. What was the new loan production weighted average yield for the quarter?
The weighted average rate for Q4 was 3.98%. The you know, the majority of our loans were in multifamily and CRE non-owner occupied, and those hovered more around low 4s, high 3s.
Just one last question from me. On the expense side, I appreciate kind of the range you provided, Heather, on the expense to average asset range. I seem to recall in the past you kind of talked about maybe moderating or modifying the accruals for commissions because I think you tend to have a much higher kind of commission run rate towards the end of the year as your lenders hit their goals and exceed their goals. As we think of the progression over the course of 2023, is the progression that we saw in 2022 what you'd expect, or would you think it would be a little more moderate quarter to quarter?
I think that our commission structure, the way that it is, and this is the function of evolving from a private company to a public company. I think we're getting better at that in terms of making sure that we're on top of the accruals. As they do, because we have a tiering structure on our commissions, and also some bonus commissions associated with interest-free demand deposit growth, and that's a fourth quarter calculation. That's always gonna be embedded in our commission run. There's always gonna be a higher degree of commissions Q4 than other quarters. We think just outside of that, for the most part, it's gonna be pretty smooth.
Very much.
Great.
Again, if you have a question, please press star then one. This concludes our question and answer session. I would like to turn the conference back over to management for any closing remarks.
Great. Thank you. I want to thank everyone for joining us as we discuss the quarterly and annual results. 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 a speed to serve and a certainty of execution. Importantly, our customers trust us and 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 continue to build meaningful relationships as we serve our shareholders, customers, employees, and community. Please contact me or Heather if you have any other questions.
We look forward to speaking with you again after our first quarter to discuss earnings for the first quarter of 2022. Have a great day, and thank you for listening.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.