FS Bancorp, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods. FS Bancorp is the holding company for 1st Security Bank of Washington, a community bank operating primarily in the Puget Sound region, with commercial and consumer banking and home lending segments. Dollar amounts below are in millions unless noted.
Financial performance and condition
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income | $11.0 | $8.8 | $30.0 | $24.7 |
| Net income | $3.45 | $3.46 | $10.41 | $7.95 |
| Diluted earnings per share | $1.07 | $1.18 | $3.31 | $2.66 |
| Net interest margin | 4.70% | 4.55% | 4.63% | 4.36% |
| Efficiency ratio | 66.4% | 64.5% | 67.5% | 67.4% |
- Q3 results: Net income was essentially unchanged. Higher net interest income after loan-loss provision was offset by lower noninterest income, higher expenses, and higher income tax expense. Total interest income was $12.4 million; noninterest income was $6.4 million. Provision for loan losses was $450,000.
- Nine-month results: Net income rose 30.8%, primarily reflecting higher net interest income after provision. Noninterest expense increased 14.1% to $32.9 million; salaries and benefits rose $3.7 million.
- Balance sheet at September 30: Total assets were $993.9 million, up 20.0% from year-end 2016. Net loans were $753.9 million, up 27.1%; deposits were $840.6 million, up 18.0%; stockholders’ equity was $118.2 million, up 45.9%.
- Funding and debt: Cash and cash equivalents were $31.3 million, down from $36.5 million at year-end. Borrowings were $10.3 million, down from $12.7 million; the subordinated note had a $10.0 million principal balance and $9.8 million carrying value. Brokered deposits totaled $102.2 million. The Bank reported $235.8 million of unused FHLB borrowing capacity, plus a $96.0 million Federal Reserve line and $43.0 million of correspondent Fed Funds lines; no Federal Reserve or Fed Funds advances were outstanding.
- Cash flows, nine months: Operating cash flow was $1.0 million, investing cash flow was negative $156.8 million, and financing cash flow was $150.6 million. Cash declined $5.2 million to $31.3 million. Investing outflows included net loan growth and $32.3 million of portfolio loan purchases; financing inflows included deposit growth and a stock offering.
- Credit quality: Allowance for loan losses was $10.6 million, or 1.4% of gross loans excluding loans held for sale, versus 1.7% at year-end 2016. Nonaccrual loans were $1.3 million, about 0.2% of gross loans, versus $721,000 at year-end. Nine-month net charge-offs were $63,000. No foreclosed real estate was held at quarter-end.
- Capital: The Bank was categorized as well capitalized. At September 30, its total risk-based capital ratio was 16.14%, Tier 1 risk-based ratio 14.89%, and Tier 1 leverage ratio 12.50%.
Material changes and notable items
- Loan growth was broad-based, led by one-to-four-family real estate, construction and development, consumer, and commercial business lending. Gross loans rose to $765.6 million from $605.4 million at year-end 2016.
- Q3 net interest margin improved year over year as higher-yielding loans made up more of earning assets. Deposit costs increased in the quarter, while loan-sale gains fell year over year.
- Noninterest income for the first nine months rose 3.7% to $18.8 million. A $996,000 gain on sale of mortgage servicing rights contributed, while gain on sale of loans declined $882,000.
- The Company issued 587,234 shares at $47 per share in Q3, generating $25.6 million net proceeds. Most funded a $26.0 million contribution to the Bank to support planned growth over the next 24 months. Shares outstanding increased; Q3 diluted EPS declined year over year despite broadly unchanged net income.
- Mortgage servicing rights declined to $5.8 million from $8.5 million at year-end, following a sale and amortization. Their valuation is sensitive to prepayment speeds and interest rates.
Outlook, risks, and contingencies
- No specific earnings or financial forecast is provided. Management said it expects continued lending growth, citing Pacific Northwest economic conditions, and stated that offering proceeds support planned growth over the next 24 months. Management also emphasizes lower-cost relationship deposits and maintaining asset quality.
- Key disclosed risks include credit deterioration, interest-rate and margin changes, loan-sale market conditions, deposit retention and funding costs, competition, expense control, execution of growth plans, and reliance on third-party vendors. The filing cautions that interim results are not necessarily indicative of full-year results.
- Outstanding commitments to extend credit were $347.1 million, including $82.1 million of undisbursed construction and development loans. These commitments may not all be drawn. The Bank also disclosed limited recourse obligations on certain loans sold and a $1.0 million reserve for repurchase and indemnification exposure on loans sold.
- Management reported no material pending legal actions and no material change to previously disclosed risk factors. Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported.
- The Company expects adoption of the credit-loss standard (CECL) to increase its allowance through a one-time retained-earnings adjustment; the magnitude was not yet known. Management did not expect the other listed upcoming accounting standards to have a material impact based on its current assessment.
Important facts for investors to verify
- Whether rapid loan growth can be sustained without deterioration in delinquencies, nonperforming loans, charge-offs, or allowance adequacy.
- Whether deposit growth remains relationship-based and how brokered deposits and rising deposit costs affect funding and margins.
- Whether home-lending production, loan-sale margins, and servicing-rights valuations remain resilient amid rate and prepayment changes.
- Whether rising salaries, commissions, and other operating costs are matched by revenue growth, given the weaker Q3 efficiency ratio.
- How the increased share count affects per-share results and how the capital contribution is deployed against planned growth.
- Exposure to contractor and geographic concentrations: four home-improvement contractors/dealers accounted for 45.5% of Q3 funded volume, and California consumer loans totaled $42.9 million.