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.

Rating Sensitivities

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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Methodologies

Financial Institutions: Bank & Bank Holding Company Global Rating Methodology

ESG Global Rating Methodology

Disclosures

A description of all substantially material sources that were used to prepare the credit rating and information on the methodology(ies) (inclusive of any material models and sensitivity analyses of the relevant key rating assumptions, as applicable) used in determining the credit rating is available in the Information Disclosure Form(s) located here.

Information on the meaning of each rating category can be located here.

Further disclosures relating to this rating action are available in the Information Disclosure Form(s) referenced above. Additional information regarding KBRA policies, methodologies, rating scales and disclosures are available at www.kbra.com.

About KBRA

Kroll Bond Rating Agency, LLC (KBRA) is a full-service credit rating agency registered with the U.S. Securities and Exchange Commission as an NRSRO. Kroll Bond Rating Agency Europe Limited is registered as a CRA with the European Securities and Markets Authority. Kroll Bond Rating Agency UK Limited is registered as a CRA with the UK Financial Conduct Authority. In addition, KBRA is designated as a designated rating organization by the Ontario Securities Commission for issuers of asset-backed securities to file a short form prospectus or shelf prospectus. KBRA is also recognized by the National Association of Insurance Commissioners as a Credit Rating Provider.

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