Welcome to the Five Star Bancorp Second Quarter 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, 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 may results 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, please see the company's annual report on Form 10-K for the year ended December 31st, 2021, and in particular, the information set forth in Item 1A, 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 well as reconciliation 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 would 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 Second Quarter of 2022. Joining me here 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 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 executive management team. The second 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 and deposits and total assets have consistently grown since the prior periods.
Our pipeline continues to remain substantial at the end of the second quarter of 2022 within the verticals we have historically operated in, as presented in the loan portfolio diversification slide. Non-PPP loans held for investment, a non-GAAP measure that is reconciled in our press release, increased during the quarter by $301.9 million, or 14.52% from the prior quarter, primarily within the commercial real estate concentration of the loan portfolio. All PPP loans have been forgiven, paid off by the borrower, or charged off as of June 30, 2022. Loan originations excluding PPP loans during the quarter were approximately $440.5 million, and payoffs excluding PPP loans were $138.1 million.
Additionally, $1.5 million of PPP loans were forgiven, ultimately resulting in a net increase in loans of $300.4 million from the prior quarter. Asset quality continues to remain strong, with non-performing loans representing 0.02% of the portfolio, slightly decreasing from the last several quarters. At quarter end, there were two loans totaling $0.1 million in the aggregate on COVID-19 deferment. We anticipate all borrowers to return to their pre-COVID-19 contractual payment status after their COVID-19 deferments end. At the end of the second quarter, the allowance for loan losses totaled $25.8 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 excluding PPP loans, a non-GAAP measure that is reconciled in our press release, was 1.08% at quarter end. Loans designated as substandard totaled $1.2 million at the end of the quarter, representing a decrease in substandard loans of approximately $1.8 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 second quarter, deposits decreased slightly by $1.8 million, or 0.07% as compared to the previous quarter. Non-interest-bearing deposits as a percent of total deposits at the end of the second quarter increased to 40.2% from 37.6% at the end of the previous quarter. We've had strong deposit growth over the last several quarters, with deposit balances remaining relatively consistent from the prior quarter. Non-interest-bearing deposits increased by $64.8 million, while interest-bearing deposits decreased by $66.6 million. Cost of total deposits was 17 basis points during the second quarter. We continue to be well-capitalized, with all capital ratios well above regulatory thresholds for the quarter. Net income for the quarter was $10 million.
Return on average assets was 1.45%, and return on average equity was 17.2%. New loan originations drove increases in the daily average balance of loans period over period. Additionally, the company recognized $24,000 of PPP income based on forgiven loans during the quarter. Average loan yield for the quarter was 4.47%, representing a decrease of 6 basis points over the prior quarter. As a result of these factors, our net interest margin was 3.7% for the quarter, while net interest margin for the prior quarter was 3.6%, which also included $600,000 of PPP income recognized based on forgiven loans.
The change in the yield curve as a result of interest rate hikes that occurred during the quarter had a negative impact on the company's accumulated other comprehensive income in the amount of $5.5 million, primarily in our mortgage-backed and municipal securities portfolios, resulting in decreases to each of those portfolios of $7.3 million and $5.2 million, respectively. This caused a 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 a slight increase in equity as a result of net income earned in the quarter, paired with a decline in total shares outstanding at the end of the period as a result of various stock forfeitures that occurred during the quarter.
This resulted in a net increase in tangible book value per share of $0.12. Non-interest income decreased to $2 million in the second quarter from $2.2 million in the previous quarter, due primarily to a decrease in other income as a result of a $300,000 gain recorded on a distribution received on an investment in a venture-backed fund in the prior quarter, which did not recur during the current quarter. This decrease was partially offset by an increase in loan-related fees of $200,000 due to an increase in swap referral fees recognized during the quarter.
Non-interest expense increased to $10.2 million in the second quarter from $9.6 million in the previous quarter, driven largely by an increase in other operating expenses as a result of an increase in travel related to attendance of professional events, conferences, and other business-related travel during the quarter. Now that we have discussed the overall results of operations, I will now hand it back to James to provide some closing remarks.
Thank you, Heather. I want to thank everyone for joining us today as we discuss the second quarter results. The strength of the bank's second quarter financial results continues to be emblematic of a reputation built on trust, speed to serve, and certainty of execution, which supports our clients' success. Our financial results are also a result of truly differentiated customer experience, which powers the demand for Five Star Bank's relationship-based services. We are pleased to have recently received a Super Premier rating from the Findley Reports, an IDC rating of Superior. Additionally, the company's Bauer rating is a five-star rating. We attribute these ratings to our prudent business model and treating customers with an empathetic spirit, understanding, and care. We are very proud to have earned the trust of those we serve, including our shareholders.
Looking to the second half of 2022, we will be guided by a continued focus on shareholder value as we monitor market conditions. We are confident in the company's resilience in any interest rate environment and will continue to execute 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 that you might have.
We will now begin the question-and-answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Andrew Terrell with Stephens. Please go ahead with your question.
Hey, good morning.
Morning, Andrew.
Morning.
James, maybe just to start, this was just an exceptional kind of growth quarter. I was hoping you could discuss maybe how the pipeline or give us a sense of where the pipeline in the third quarter was shaping up versus the prior quarter. Are you seeing any kind of a slowdown given kind of the move up in rates we've seen? Then I would assume also on the other end, payoffs are slowing down as well. Hopefully you could just provide us kind of updated expectations on how overall net loan growth shapes up in the second half of the year.
Sure. Our loan pipeline is less than what it was when we entered into the second quarter by a fair amount. Our deposit pipeline has actually grown. Where we sit today is that our deposit pipeline is substantially larger than our loan pipeline. I think it's safe to say it'd be very difficult for us to experience the same amount of loan growth in the second half of the year as we saw in the first half. The deal flow has slowed, but it's still there. We're still very busy. I don't think we're gonna experience the same degree of loan growth that we saw in the first half of the year, and in particular, the second quarter, for Q3 and Q4 as we go out.
Expectations are probably a 5%-10% loan growth for the remainder of the year and probably, if we perform well on the deposit side, deposit growth between 10%-15% for the remainder of the year. We have a lot of large relationships that we're onboarding right now, and we're excited about those opportunities and everything else that the market is bringing us right now.
Great. That's really encouraging to hear, especially on the deposit growth front. I think last quarter, we might have talked about loan yields, I think, potentially lying down a bit for the next couple of quarters just before expanding, as a function of kind of the pipeline funding up. I was just hoping to get a sense of where new originations came in at during the second quarter. And then I would imagine just given the volatility in rates upward that we've seen that you're kind of funding loan growth at a higher yield now. I was just hoping to get a sense of kind of trajectory of the loan yields.
Yeah. I can take that, Andrew. For Q2, our weighted average rate was about 4.65%, you know. Driving that primarily was our fundings in the multifamily concentration, which came in about 4.57%. It was pretty much the bulk of the funding for the period. I'll let James provide some color.
Sure.
If he-
You know, the loans that we're approving in committee over the last month or substantially all of which had five handles on it. We are pricing up naturally speaking. We're a spread shop and, you know, we spread off the five year or the 10-year and with our CRE lending. We are seeing, you know, the actual rates on those deals being higher than our loan yield that we currently have in our loan portfolio. It's our expectations that loan yields will grow and based upon the amount of volume that we put on. Which is nice to see.
You know, for the longest period of time, Andrew, we were making loans that were less in terms of yield, were less than what was in the portfolio, which is not a winning strategy, you know, per se, but we think that that's turned around.
Yeah. Okay. Got it. Maybe sticking on kind of the margin, if I look at the move in the interest-bearing deposit costs this quarter, I guess if I just run the math, I get to like a 20% interest-bearing deposit beta for 2Q. Maybe for Heather, do you think that beta should kind of hold around 20% through the rate cycle, or are you seeing deposit rate competition kind of more meaningfully accelerate so far in the third quarter? Can you just remind us overall of where you kind of target the deposit beta through the cycle?
Sure. Yeah. We actually use an internal estimate of about 30% for our betas on deposits. You know, we do have our large governmental book that kind of holds that steady as we have inflows and outflows. We're kind of using 30% as our estimate.
Yeah. Okay. Do you have the spot, either interest bearing or total deposit costs at June 30th?
Total cost of deposits at June 30th was 22 basis points. We could kind of see that almost doubling by the end of September, just given the composition of our deposit book, you know, the rising rates on the LAIF rate that we tie our governmental book to. All in, that could go up to 44-50 basis points by the end of Q3.
Yeah. I think it's important to note, because of the fact that we don't have a very granular deposit base per se, we've got a lot of large relationships. Each one of those relationships have negotiated pricing. It's difficult to kind of across the board determine, you know, where that's going to end up. We're responsive from a pricing perspective. I think that it's with each Fed move, there's more pressure with respect to some of our interest-bearing deposits to move up. Each relationship stands on its own in terms of the negotiated pricing associated with it.
Okay. Understood. Well, I'll step back on the queue. I appreciate you taking my questions.
Sure.
Our next question comes from Gary Tenner with D.A. Davidson. Please go ahead with your question.
Thanks. Good morning, everybody.
Hey, Gary.
Hey. I appreciate the thoughts on the deposit pipeline, obviously with the loan deposit ratio creeping up as it did during the quarter. You know, this should help moderate it a bit. Could you give us a sense as to kind of what the rate of that deposit pipeline looks like? I know, Heather, you just provided some thoughts on where deposits could go by the end of the quarter, but just curious kind of what the marginal cost of funding looks like right now.
A lot of commercial accounts. If I was to blend it's probably maybe at or slightly above where we are right now at the end of second quarter. I think that would be new production per se. We expect to continue to grow our non-interest bearing deposits. Gary, you can see a pretty substantial increase the first half of the year. I think through 30 June , over $100 million in non-interest bearing deposits. That has a tendency to kind of drive down, obviously your costs.
Our pipeline is replete with those types of opportunities, as we continue to take advantage of, you know, folks in the market, in particular the majors and other, I'm gonna say merger-related entities or merger-affected entities, which has been kind of a nice little windfall for us.
Got it. Thank you. On the fee side, obviously pretty steep drop that we've seen at your institution and others as it relates to SBA premiums. Any thought to, you know, kind of keeping more on portfolio given how low those premiums are? Or does balance sheet management and funding dictate that you continue to sell?
Well, that's a great question. We've never portfolioed any SBA loans. We've always originated for sale, and I expect we're going to continue to do that. There is some things going on in SBA that's of note. SBA is moving up their max pricing, if you will, pretty substantially, frankly. We're not in a position to determine like, what do we wanna do yet. I think it's a wait and see with respect to what the investors, the folks who buy our loans, you know, what do they make about those pricing increases, which are either 50 basis points to 100 basis points higher than what the max pricing SBA allowed.
Not sure about the policy behind it, but nevertheless it's going to be in place, I think, in the first week of August. That could affect premiums. We just don't know what that looks like right now. The premiums have drifted down, as you noted. Our SBA function is still very profitable and, you know, the volumes, we wish they were a little higher, but they are what they are. We'll continue to sell.
Great. Then lastly for me, I think historically your comp program's set up to where as your business development officers kind of hit their numbers, you know, you had that ramp of comp in the back half of the year. I think particularly with your thoughts on the pipeline, which I know is a big part of that incentive program, should we expect to see sort of that upward trajectory again in the back half of this year based on how that pipeline looks?
Well, I think, you know, we do have some specialist incentives for deposits. You know, with the loan production, the first half of the year was $750 million . So a lot of guys were already at the highest tier. I'm gonna say at least half of them are. You know, Q2 commissions were pretty good for them. You know, we're happy to be able to do that. I think that you probably could see some maybe slightly less consistent with last year in terms of commission growth. It all depends on how well we execute on the deposit side in terms of new accounts and new relationships.
Okay. Thanks for taking my questions.
Our next question comes from Stuart Lotz with KBW. Please go ahead with your question.
Hey, guys. Good morning. How's it going?
Hey, Stuart. How you doing?
Good. James, quantify the loan growth outlook. You know, what is, you know, I appreciate that the pullback, just given the backdrop. You know, this quarter, $300 million, and I think, you know, over the last about four quarters, you've averaged, you know, above 30% annualized growth. Just in terms of dollar amounts, how are you thinking about the growth pipeline for the back half?
Oh, you know, probably in the neighborhood of $100 million-$125 million per quarter remainder of the year. Is that helpful?
I mean, just given the mix in recent quarters has really come from the manufactured housing book, or manufactured home book. Can we expect, you know, that to continue to drive the growth from here? Or do you anticipate, you know, pulling back, just given concentration issues?
Um, you know, we don't-
Concentration mindset.
Yeah. Good. Thank you. We don't anticipate pulling back in terms of, that particular vertical and lending into that space. We really like the credit characteristics. We like the granularity, geographic granularity, associated with that business. And, we just think that that asset class, based upon our research, has always performed well in any type of economic environment and in particular, a downturn. We think that we're well protected in terms of lending into that space. We don't plan to, stop or modify what we're doing. But we will say that, you know, the market has slowed. I think there's less acquisition, park acquisition going on. I think rates have clicked up.
Buyer and seller expectations are wider spread than they once were with cap rates rising. We've definitely seen a slowdown in that business. It's still pretty decent.
Okay. Got it. Great. Maybe while I'm making a capital question. You know, I think historically you've operated, you know, with the CRE, you know, as high as about 700% of total risk-based capital. Kind of by my math, this quarter, you guys are kind of back in that range. You know, any thoughts about, you know, potential capital? I know you're looking at, you know, potential sub-debt rates at some point to reprice your existing sub-debt. Just wanna get your thoughts on how high you're willing to let that ratio go before, you know, looking to raise some, you know, additional capital for growth.
Well, as you, Stuart, as you know that we've always talked about us executing on that refinance. I think that our thinking is consistent with respect to that. I think that there should be or could be an expectation that we would execute on that by the end of the year. That could provide us, if we do it, with additional capital into the bank and lower those concentration levels for CRE that you just referenced.
Would you potentially look at just given your, you know, the strength of the currency right now, you know, raising equity capital, just given, you know, how high kind of sub-debt pricing is today and, maybe, you know, what would, you know, kind of drive difference for one or the other from here?
That's a good question. Let's do the math together, if we could. We're nowhere near 125% double leverage ratio right now. We kinda like that number as a ceiling, Stuart.
Okay.
You could probably back into that in terms of what a size would be if we did a sub-debt deal, number one. If we're making 17% after a $2.3 million provision on equity, I think that, you know, my understanding of the current sub-debt market in terms of an interest rate, we'd do pretty well with that, don't you think?
Yeah. I would agree. You know, just given you know, kind of what we've seen. I mean, obviously, there's been a pullback in that market. But just given the strength of, you know, of your currency from a price to tangible book standpoint, you know, I feel like, you know, common equity might make sense at these levels too.
Sure. You know, we wanna make sure that we don't have blinders on with respect to capital at all. We wanna make sure that we comprehend any opportunity that might be out there in the marketplace. You know, we are trading at a, I think, a pretty nice premium to book, which not everybody enjoys. Definitely hear you when you say, you know, our valuations are favorable with respect to future equity raises.
Appreciate all your color there. Maybe one more for Heather. Just turning back to expenses. Do you have what the deferred loan origination costs were this quarter? And maybe if you could kinda, you know, hone in on a run rate for what you think the third quarter expense base could be?
So let me-
I think it's-
Yeah. Let me pull up that really quickly. I don't think we did. Did we break that out in the earnings release for you all? I don't believe we did.
May have missed that.
Let me pull it up for you. One moment. Actually, let me get back to you on that one. We can hop in, hop out.
Okay.
out of the queue and hop back in. I'll pull that for you.
Okay, great. All right, thanks for taking my questions.
Thank you.
Our next question comes from Andrew Terrell with Stephens. Please go ahead with your question.
Hey, thanks for the follow-up. James, I wanted to ask you, I think you alluded to it maybe a little bit in some of your prepared remarks, but I know part of the organic growth story has been driven by just your success and your ability in hiring talent away from other institutions. I was hoping to get an update on any kind of progress made over the past quarter in terms of new business development, hires, and then what the pipeline for that specifically looks like going forward.
Well, right now as we sit here, there's nobody that's we have our eye on a few people, but there's no, you know, somebody who's actively in the queue at this point. We have a pretty complete business development team that is doing a great job. We've had the opportunity to build out a couple of our verticals with additional hires this year, whether it's in our faith-based business, our venture banking business, and also our Ag business. We feel like we've got a pretty strong complement right now. We usually like to have, Andrew, two biz dev people in each vertical we're in, each substantial vertical, and I think that we certainly have that. We're doing quite well even in our practice group.
We've got fundamentally two and a half people in there now. We're seeing a lot of growth come through that particular business, and I'm talking about the dentistry and the veterinary clinics, and whatnot, to some extent CPA practices. We kinda like where we are right now. That's not to say we wouldn't, if it came to pass that we have an opportunity to land somebody, we wouldn't jump all over it.
Mm-hmm.
You know, right now, you know, where we are, we think we're very strong and from a business development perspective. To answer your question, we don't really. We're not looking to. We don't have anybody in the queue right now.
Okay. No, that's really helpful. I appreciate the color. Last one for Heather. Looking at the reserve ratio, it ticked down a little bit this quarter just given the strong loan growth. I know you're running CECL parallel right now. Curious if you had any kind of preliminary day one CECL estimates that you were able to share with us.
At this moment, we don't have a preliminary day one estimate. We did do our first parallel run as of June 30. But we are still working through our qualitative factors. You know, this is definitely a learning experience for all of us navigating CECL adoption for first-year adopters. You know, we're finding our quantitative side is coming out rather high, and so we need to make sure that we're looking at, you know, our underwriting practices and our experience of management and what we're doing in-house to adjust for those qualitative factors to make sure that we have an appropriate reserve. Hopefully in Q3, we'll be able to provide at least an estimate so then that way you all can start looking as we get closer to the end of the year.
Okay. Perfect. Thanks for the follow-up questions.
This concludes our question- and- answer session. I would like to turn the conference back over to James Beckwith for any closing remarks.
Great. Thank you. Five Star 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. At Five Star Bancorp, we seize opportunities and embrace challenges and value the intrinsic reward of serving others. We look forward to speaking with you again in October to discuss earnings for the third quarter of 2022. Have a great day, and thank you for listening.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.