FS Bancorp, Inc. quarterly report, Q2 FY2012

FS Bancorp, Inc. — Q2 2012 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2012. Unless otherwise indicated, amounts below are in millions of dollars. At June 30, FS Bancorp had not completed its formation-related conversion and had no shares issued, assets, liabilities, or operating activity; the reported financial statements are for 1st Security Bank of Washington. The conversion and public offering closed July 9, 2012.

Financial performance

Metric	Q2 2012	Q2 2011	Six months 2012	Six months 2011
Interest income	$4.50	$4.07	$8.80	$8.26
Net interest income	$3.89	$3.28	$7.54	$6.64
Provision for loan losses	$0.55	$0.57	$1.07	$1.03
Noninterest income	$1.12	$0.56	$1.85	$1.10
Noninterest expense	$3.84	$2.83	$7.42	$5.70
Net income	$0.62	$0.44	$0.90	$1.01

Q2 net income rose about 40% year over year; first-half net income fell about 11%. No income tax provision was recorded; the stated effective tax rate was 0%.
First-half net interest margin was 5.23%, up from 4.98% a year earlier. The six-month cost of interest-bearing funds fell to 1.02% from 1.42%. The six-month efficiency ratio increased to 79.1% from 73.7%.
Q2 noninterest income included $445,000 in mortgage-loan sale gains and $94,000 in securities sale gains. First-half gains were $551,000 and $106,000, respectively.
Higher operating costs weighed on results: first-half salaries and benefits increased $881,000, while OREO write-down expense rose $529,000 from the prior-year period. Management attributed expense growth to expanded lending platforms and property-related costs.

Financial position, funding, and cash flow

At June 30, total assets were $340.9 million, up 20.1% from December 31, 2011. Net loans were $245.2 million, up 12.9%; available-for-sale securities were $37.9 million; and cash and cash equivalents were $33.2 million.
Total deposits were $307.4 million, up 24.7%, including $40.7 million of conversion-offering subscription funds held in savings. Borrowings were $4.1 million, down from $8.9 million. Equity was $27.9 million.
For the first half, operating cash flow was negative $1.5 million, investing cash flow negative $40.7 million, and financing cash flow positive $56.2 million; cash increased $14.0 million to $33.2 million. Financing inflows included $61.0 million of net deposit growth, partly offset by net borrowing repayments.
Liquidity sources included unused FHLB capacity of $23.2 million, an $83.1 million Federal Reserve borrowing line with no advances outstanding, and a $6.0 million unsecured bank line. Outstanding loan commitments were $77.1 million; certificates of deposit of $44.9 million were scheduled to mature within six months.
The Bank was categorized as well capitalized at June 30: total risk-based capital ratio 11.27%, Tier 1 risk-based ratio 10.02%, and Tier 1 leverage ratio 8.88%.

Material changes and credit quality

Loan growth was concentrated in commercial business loans, up 31.4% to $57.0 million, and real estate loans, up 22.4% to $77.7 million. Commercial business growth reflected refinancing activity among warehouse-lending borrowers. Consumer loans were nearly flat at $114.7 million.
The allowance for loan losses was $4.3 million, or 1.7% of gross loans, versus 2.0% at year-end. First-half net charge-offs were $1.1 million, down from $2.1 million in the prior-year period.
Nonaccrual loans declined to $1.7 million from $2.2 million at year-end; nonperforming assets fell to $4.7 million from $6.9 million. OREO was $3.0 million, after $594,000 in first-half fair-value write-downs and $2.0 million in dispositions.
Total troubled debt restructurings were $3.3 million: $2.2 million on accrual and $1.1 million on nonaccrual. Classified loans included $3.9 million substandard and $0.8 million special mention at June 30.

Outlook, risks, contingencies, and unusual items

On July 9, 2012, the conversion made the Bank a wholly owned subsidiary of FS Bancorp. The holding company raised approximately $32.4 million by issuing 3,240,125 shares and contributed $15.5 million to the Bank. Shares trade on Nasdaq as FSBW. The quarter-end figures do not include this subsequent transaction.
Management described plans to expand commercial real estate, commercial business, and residential construction lending while maintaining the consumer portfolio. It was preparing a limited California test for indirect home-improvement lending; no loans had yet been originated there. No numerical earnings or growth guidance was provided.
Key disclosed risks include economic and real estate deterioration, loan losses and collateral valuations, interest-rate and margin changes, deposit retention, execution and cost control during growth, regulatory changes, competition, litigation, and reliance on third-party vendors. Indirect home-improvement lending depends on a dealer network of about 160 active contractors, with more than half of volume attributable to roughly 10.
The Bank retained a full $2.9 million valuation allowance against deferred tax assets despite recent profitability; management said it would reassess the allowance in the third quarter. Its net operating loss carryforward was approximately $6.4 million.
The Bank reported $77.1 million of commitments to extend credit, which may not all be drawn. Management said ordinary-course legal claims were not expected to materially affect financial condition. In the McClain matter, the plaintiff’s claims had been dismissed with prejudice; the filing reports the appeal was dismissed July 13 and the case remanded for further proceedings. The Bank’s counterclaims remained under evaluation.
Management reported disclosure controls were effective as of June 30 and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

How the $32.4 million offering proceeds, $15.5 million Bank contribution, and conversion costs affected post-quarter capital, share count, and liquidity.
Whether loan growth—particularly commercial business, construction, and indirect consumer lending—continues without deterioration in delinquencies, nonperforming assets, or charge-offs.
Whether higher expenses and the 79.1% first-half efficiency ratio improve as lending platforms mature, and whether mortgage-banking gains are recurring.
Management’s subsequent assessment of the deferred-tax-asset valuation allowance and the remaining legal proceedings in the McClain matter.
Deposit retention and liquidity around the $44.9 million of near-term certificate maturities, $77.1 million of commitments, and the substantial offering-related deposits present at quarter-end.