KBRA Affirms Ratings for Five Star Bancorp
26 Jul 2023 | New York
KBRA affirms the senior unsecured debt rating of BBB, the subordinated debt rating of BBB-, and the short-term debt rating of K3 for Rancho Cordova, CA-based Five Star Bancorp (NASDAQ: FSBC) (“the company”). In addition, KBRA affirms the deposit and senior unsecured debt ratings of BBB+, the subordinated debt rating of BBB, and the short-term deposit and debt ratings of K2 for Five Star Bank, the main subsidiary. The Outlook for all long-term ratings is Stable.
Key Credit Considerations
The ratings reflect the company’s durable, branch-based deposit franchise located predominantly in the Sacramento, CA MSA, providing the bank access to public agency, nonprofit, and other association deposit customers. FSBC is a spread-reliant company with less durable sources of non-spread revenue, such as gain on sale of SBA loans and loan-related fees, accounting for most of the noninterest income more recently. FSBC’s efficiency ratio (~36%) and ROA (1.55% - 1.65%) are better than similarly rated peers, driven by the bank’s above peer average deposits per branch ($416 million) as overhead costs of 1.40% of average assets are less than half of the KBRA peer average (3.20% of average assets). The company’s solid deposit franchise has come under pressure recently due to 44% loan growth in 2022, causing Five Star to rely more on non-core funding to fund the balance sheet. Total deposit costs increased to 1.35% in 1Q23 due to rising market interest rates and greater reliance on non-core funding, although costs still remain somewhat lower than the KBRA peer average of 1.43%. Slowing loan growth and continued core deposit growth should relieve stress on the funding profile in the near term. FSBC has a Western region high concentration in investor CRE of 574% of risk-based capital, with manufactured housing community (MHC) loans and similar RV loans comprising more than 40% of the CRE portfolio. Low LTVs (average 51%) across the CRE portfolio and stringent risk controls and credit management practices help to offset some of the concentration risk. In addition, the MHC product tends to be counter-cyclical and performs better than other lending categories during periods of economic weakness. Overall capital levels were negatively impacted by FSBC’s 2021 conversion to a C-corp that required the distribution of retained earnings from its prior S-corp legal status, as well as significant growth in risk weighted assets in 2022. However, these special conversion distributions have ended and KBRA expects the company to operate with a payout ratio of approximately 23% - 25%, to pause any share buybacks, and to realize slower risk weighted asset growth in the coming year, providing the ability to accrete capital to levels more consistent with rated peers over time.
An upgrade is not expected. Core regulatory capital, specifically the CET1 ratio, decreasing further could result in a negative rating action. In addition, significant deterioration in credit quality, with elevated credit costs, or increasing funding costs that materially impact earnings over multiple quarters could pressure ratings.
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