FS Bancorp, Inc. annual report, FY2020

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FS Bancorp, Inc. — FY2020 Form 10-K

Reporting period: Fiscal year ended December 31, 2020. This is an annual report, not a standalone Q4 earnings filing. FS Bancorp is a Washington community bank holding company whose principal subsidiary, 1st Security Bank of Washington, serves the Puget Sound region and operates a broader indirect consumer lending business.

Financial performance and condition

  • Scale and growth: Total assets were $2.11 billion, up $400.2 million (23%) from year-end 2019. Gross loans were $1.57 billion, up 16%; deposits were $1.67 billion, up 20%. Stockholders’ equity was $230.0 million, compared with $200.2 million.
  • Profitability: Net income rose 73% to $39.3 million; diluted EPS was $8.97 versus $5.01. Net interest income increased to $74.1 million from $70.3 million. Return on assets was 2.02% and return on equity 18.74%.
  • Revenue and margins: Noninterest income increased to $55.4 million from $23.0 million, mainly as gain on loan sales rose to $48.8 million from $14.2 million amid higher mortgage production and sales. Net interest margin fell to 4.02% from 4.53%; average earning-asset yield fell to 4.82% from 5.77%, while average interest-bearing funding cost declined to 1.07% from 1.64%. The efficiency ratio improved to 51.43% from 66.78%.
  • Credit and allowance: Provision for loan losses was $13.0 million, versus $2.9 million. The allowance rose to $26.2 million, or 1.66% of gross loans, from $13.2 million, or 0.98%. Nonperforming assets increased to $7.9 million (0.37% of assets) from $3.2 million; nonperforming loans were $7.8 million (0.49% of gross loans), versus $3.0 million (0.22%). Net charge-offs were $93,000, compared with $2.0 million.
  • Funding and liquidity: Year-end cash and cash equivalents were $91.6 million, up from $45.8 million. Deposits included $201.4 million of brokered deposits. Borrowings totaled $165.8 million, including $102.5 million of FHLB advances and $63.3 million of PPPLF advances. The Bank reported $459.9 million of unused FHLB capacity, $179.6 million of Federal Reserve borrowing capacity, and $101.0 million in unused unsecured Fed Funds lines. Parent-company unrestricted cash was $14.5 million.
  • Capital: The Bank’s Tier 1 leverage ratio was 10.9%, and it was categorized as well capitalized under the applicable framework. Consolidated equity was 10.88% of assets, compared with 11.69% a year earlier.
  • Cash flow: Operating activities used $32.3 million, investing activities used $270.7 million, and financing activities provided $348.8 million. Cash increased by $45.8 million to $91.6 million. Mortgage originations and sales materially affect reported operating cash flow.

Material changes versus FY2019

  • Mortgage activity accelerated: the Company originated $1.87 billion of one-to-four-family mortgages and sold $1.64 billion, compared with $891.4 million originated and $785.4 million sold in 2019. Mortgage loan-sale margin increased to 2.48% from 1.74%.
  • Lower market rates and PPP lending weighed on asset yields and net interest margin, although lower deposit and borrowing costs reduced interest expense.
  • Loan growth was broad-based: commercial and industrial loans increased by $83.9 million (including $62.1 million in PPP loans), consumer loans by $49.0 million, and construction and development loans by $37.3 million. The portfolio remained diversified, with real estate loans at 58.8%, consumer loans at 23.8%, and commercial business loans at 17.4% of gross loans.
  • Credit indicators weakened as nonperforming loans and classified assets rose. Management increased COVID-19-related qualitative loss factors; risk ratings were downgraded on $103.3 million of loans considered at risk from the pandemic.
  • Deposits shifted toward more liquid accounts: transaction and savings deposits were 70.0% of deposits versus 60.4% in 2019, while certificates of deposit declined to 30.0% from 39.6%.

Outlook, risks, and notable items

  • Management provided no quantified earnings or revenue guidance. It expected COVID-19, the low-rate environment, and low-yield PPP loans to pressure net interest income and margin into 2021 and potentially longer. It also said a further economic decline could require additional loan-loss provisions.
  • At year-end, 423 PPP loans totaling $62.1 million remained outstanding; the Bank began originating renewed PPP loans in January 2021. COVID-19 payment-relief agreements covered $44.7 million of portfolio loans, excluding $4.4 million in two commercial business loans that were nonaccrual but current. These modifications were not classified as TDRs under the applicable relief guidance.
  • Key exposures include construction and commercial real estate lending, indirect home-improvement and marine consumer loans, borrower and dealer concentrations, mortgage warehouse lending, and dependence on mortgage production and secondary-market sales. The pandemic, regional unemployment, interest-rate changes, and the uncertain course of LIBOR transition add risk.
  • Unusual items included a $1.5 million gain from a one-time sale of Visa Class B shares and $2.0 million of servicing-rights impairment expense. The annual increase in loan-sale gains was the primary driver of higher net income.
  • After year-end, the Company issued $50.0 million of 3.75% fixed-to-floating subordinated notes due 2031, receiving approximately $49.3 million net, and redeemed its existing $10.0 million subordinated note on January 4, 2021. The Company repurchased $9.8 million of shares during 2020 and paid $3.6 million in common dividends.
  • The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting; the allowance for loan losses was identified as a critical audit matter. Management reported effective disclosure controls and internal control over financial reporting.

Most important facts for investors to verify

  • Whether COVID-related borrower relief, elevated unemployment, and the $103.3 million of pandemic-related risk-rating downgrades lead to additional delinquencies, charge-offs, or allowance increases.
  • How much FY2020 earnings depended on unusually high mortgage originations and loan-sale gains, and whether production and margins can be sustained as refinancing activity changes.
  • The impact of lower rates, PPP loan forgiveness and fees, and deposit repricing on net interest margin and net interest income in 2021.
  • The quality and concentration of construction, commercial real estate, commercial business, indirect consumer, and warehouse exposures, including the $133.0 million of speculative one-to-four-family construction loans.
  • Brokered-deposit reliance, large loan commitments ($528.2 million), funding capacity, and the effect of the new subordinated notes and redemption on capital, liquidity, and interest expense.
  • The timing and forgiveness of PPP loans, and the adequacy of the allowance under the incurred-loss model ahead of expected CECL adoption in 2023; the filing says the eventual CECL impact was not yet clear.