KBRA Affirms Ratings for Five Star Bancorp

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 solid earnings history supported by a comparatively higher average loan-to-earning asset mix (89% as of 1Q24 versus 79% for the rated peer group) facilitated by an above average NIM despite the higher interest rate environment pressuring funding costs. Further, aiding FSBC’s above peer earning profile is the company’s branch-lite model, resulting in lower occupancy expenses with operating costs making up only 1.37% of average assets. However, FSBC is a spread-reliant company with less stable sources of fee revenue (such as gain on sale of SBA loans and loan-related fees) accounting for just 5% of total revenue. Robust loan growth in recent years has resulted in an elevated loan-to-deposit ratio of 105% as of 1Q24. However, the company’s deposit franchise is located predominantly in Sacramento, CA, providing the bank access to public agency, nonprofit, and other association deposit customers which has, in part, supported core deposit growth. Management intends to slow loan growth to 12% annually (compared to 44% in 2022), targeting a LTD ratio between 90%-95%. In 1Q24, solid core deposit growth allowed management to reduce wholesale funding sources contributing to core deposits-to-total funding improvement to 88% as of 1Q24, up from 84% at 1Q23. In 2Q24, FSBC completed its common stock offering of 4.0 million shares bringing in net proceeds of $81 million, supporting a ~23% increase in risk-based capital metrics. Management intends to strategically deploy the proceeds to support continued growth opportunities. The company maintains an elevated concentration in investor CRE at ~574% of risk-based capital as of 1Q24 with MHC and similar RV loans comprising more than 44% of the CRE portfolio, though with the increase in capital in 2Q24, we expect this ratio to decrease to a more manageable ratio. Low LTVs (average 57%) 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.

Rating Sensitivities

A rating upgrade is not expected over the intermediate term, though continued geographic expansion, earnings and credit outperformance, and capital levels consistently in line with the higher rated category, may result in positive rating action over time. A downgrade is not expected, though maintenance of capital ratios, specially CET1, well below 10%, 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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